1. Chapter 15 Shareholders’ Equity
Prepared by:
Patricia Zima, CA Mohawk College of Applied Arts and Technology

2. Shareholders’ Equity Presentation and Disclosure
Special presentation issues
Retained Earnings
Formality of profit distribution
Types of dividends
Stock splits
Other Components
Contributed surplus
Accumulated Other comprehensive income
Corporate Form
Corporate Law
Share capital system
Share Capital
Types of shares
Limited liability of shareholders
Issuance
Reacquisition
Retirement
Perspectives
Analysis
Appendix 15A – Par Value and Treasury Shares
Par value shares
Treasury shares
Appendix 15B Financial Reorganization
Comprehensive revaluation

3. Components of Shareholders’ Equity
Share Capital:
Common
And/or
Preferred shares
Contributed Surplus
Contributed Capital
Retained Earnings
Accumulated other Comprehensive Income
Earned Capital

4. Major Sources of Changes in Shareholders’ Equity
All Transactions and Events That Cause
Changes in Shareholders’ Equity
Net Income
Transfers Between Entity and Owners
Revenues & Expenses
Gains and Losses
Investments by Owners
Distributions to Owners

5. Defining Capital Legal capital (stated capital)
the full price received for shares issued
If par value shares are issued, then legal/stated capital = par value
Par value shares are not permitted under CBCA
Permitted under some provincial jurisdictions (see Appendix)

6. Defining Capital Accounting definition of capital Share capital
Shareholders’ equity which includes:
Share capital
the legal/stated capital
Contributed surplus
equity transactions not specifically included elsewhere
Retained earnings
all undistributed income that remains invested in the business
Accumulated other comprehensive income
Cumulative change in equity due to revenues and expenses, and gains and losses from transactions not included in net income

7. Primary Forms of Business Organization
Proprietorship
Partnership
Corporation
Profit-oriented
Engaged in making financial returns for their owners
Shares publicly traded
Shares privately held
Private Sector
Public Sector
Not-for-profit
No shares issued; created to provide services for members or society
Crown
Created by government statute to provide public services
Municipalities, Cities, Etc.

8. Corporate Accounting
Special characteristics that impact on accounting:
Corporate law
Share capital system
Limited Liability

9. Corporate Law Articles of Incorporation Corporation Charter Issued
Recognized as
Legal Entity
Articles of
Incorporation
Corporation
Charter
Issued

10. Corporate Law Canada Business Corporation Act (CBCA)
Articles of incorporation prepared and submitted
Company name
Location of registered office
Classes and authorized shares
Share transfer restrictions (if any)
Directors
Business restrictions
CBCA regulations required financial statements be prepared in accordance with GAAP

11. Share Capital System Shares grouped by “class” (e.g. Class A Common)
Within each class, each share equal
Each share contains certain rights and privileges
Ease of transfer of ownership
Advantage to both issuing corporation and investor
Share becomes more attractive investment

12. Share Capital System
As a minimum each share has these basic or inherent rights
To share proportionately in profits and losses
The right to vote for directors
To share proportionately in assets upon liquidation
Preemptive right for any new share issues

13. Share Capital Common shares Represent basic ownership interest
Represents residual ownership interest - have ultimate risk of loss and benefit from success
Dividends, or assets on dissolution, not guaranteed
True advantage is in the right of Common Shares to ultimately control by way of voting

14. Share Capital Preferred Shares
Certain inherent rights given up or exchanged for other special rights or privileges
Preference given on
Dividends (usually at a stated rate)
Claim to assets on dissolution
Preferred shares features (some or all may be attached to a preferred share
Cumulative  Callable/redeemable
Convertible  Retractable
Participating

15. Share Capital Preferred Shares Features
Cumulative: Dividends in arrears must be paid before any profits can be distributed to common shareholders
Convertible: The company or holder can exchange the shares for common shares at a predetermined ratio
Callable/Redeemable: The issuing company can “call” at its option the preferred shares at specified future dates at stipulated prices
Retractable: The holders can “put” (or sell) their shares to the company
Participating: Holders can participate with common shareholders in any profit distributions higher than the prescribed rate

16. Limited Liability Limited Liability of Shareholders
Unlike partnership or proprietorship form of business
Shareholders not generally liable for the obligations of the corporation
Shareholders losses restricted to
Amount invested in the corporate shares

17. Accounting for the Issuance of Shares
Shares basic
Shares sold on a subscription basis
Defaulted Subscription accounts
Shares issued in combination with other securities

18. Shares Issue - Basic
Full amount of proceeds received is credited to the respective share capital account (preferred/common/class type)
500 common shares are sold for $10.00 each (issuance costs not included in this transaction). The journal entry is:
Cash 5,000
Common Shares 5,000

19. Shares Sold by Subscription
Shares are sold, with “instalment” payments
Shares are not issued, and any rights are not given (e.g., voting, dividends) until the full subscription price is received
Dividends may be attached to some subscription shares, once the initial payment is received

20. Shares Sold by Subscription
Accounts in share subscription transaction
Shares Subscribed
Set up a separate one for each type/class of share
An equity account, reported below the respective share capital account on the Balance Sheet
Subscription Receivable
Normally considered a current asset
May be reported as a contra account to the Shares Subscribed account in equity section of the Balance Sheet
Share Capital
Credited only when the subscription is paid in full, or settled in some other manner, in the case of default

21. Shares Sold by Subscription
If a subscription contract is defaulted there are generally three possible consequences:
Funds paid to date are refunded, often with a deduction for expenses, and the balance of the contract is cancelled
Funds paid to date are forfeited transferring it to the Contributed Surplus account, with no refund or shares being issued; balance of the contract is cancelled
Shares are issued for the amount paid to date, with the balance of the contract cancelled

22. Shares Sold by Subscription
500 shares are sold on subscription for $20.00 each. 50% is due as initial payment.
The initial journal entries would be:
Subscription Receivable 10,000
Shares Subscribed 10,000
Cash ,000
Subscription Receivable ,000

23. Shares Sold by Subscription
If all payments are made as scheduled, the entries would be:
Cash ,000
Subscription Receivable 5,000
Shares Subscribed 10,000
Share Capital 10,000
If the subscriber defaults, one of the following may happen (depending on the contract terms and applicable legislation).

24. Shares Sold by Subscription
Default after first payment – funds refunded with no penalty.
Shares Subscribed 10,000
Accounts Payable (or Cash) 5,000
Subscription Receivable 5,000
Default after first payment – shares issued for amount paid.
Shares Subscribed 10,000
Share Capital 5,000
Subscription Receivable 5,000

25. Shares Sold by Subscription
Default after first payment – funds held by corporation.
Shares Subscribed 10,000
Subscription Receivable 5,000
Contributed Surplus 5,000

26. Shares Issued With Other Securities
When two or more classes of shares are sold for a lump sum
Accounting problem is the allocation of the funds received to the respective share classes
Two methods available
Proportional method (relative market value method)
Incremental method

27. Accounting for Share Issue Costs
Include legal fees, accounting fees, underwriter fees & commissions, printing and mailing costs, advertising and administrative expenses of preparation
CICA Handbook (Section 3610) deems these amounts to be capital transactions (rather than operating transactions) and therefore should not be included in net income calculation
Accounting treatment—debit to Share Capital

28. Accounting for Share Issue Costs
Reduction of the amount paid in
1,000 shares sold for $10.00 each, with $500 in issue costs
Cash 9,500
Share Capital
Share Capital 10,000

29. Share Repurchase
Major reasons for the reacquisition of a corporation’s own shares
Reduce the shares outstanding to increase EPS
Have enough shares on hand to meet employee share compensation contracts
Buy out a particular ownership interest
Meet the needs of a potential merger
Stop (or slow down) takeover attempts
Reduce number of shareholders
Make a market in the company’s shares
Return cash to shareholders

30. Share Repurchase Other reasons may include:
Reduce the operations of the business
Change the debt-to-equity ratio
Settle a debt
Provide a boost to shareholders (remaining shareholders end up with a larger portion of the entity)
Fulfill the terms of a contract
Satisfy a claim from a shareholder
Change from a public to a private corporation

31. Reacquisition of Shares
Shares may be retired when reacquired
May also (in limited circumstances and jurisdictions) become Treasury Stock (see Appendix)
In Canada, the CBCA requires repurchased shares be cancelled and restored to status of authorized but unissued, if a limit to authorized shares exists
In either case, the accounts affected are:
Share Capital
Contributed Surplus
Retained Earnings
Treasury Stock (for Treasury Stock only)

32. Reacquisition of Shares
Share capital debited with the original issue or assigned value only
The difference then allocated to equity accounts:
Contributed Surplus
Retained earnings
Contributed Surplus NEVER goes to a debit balance

33. Reacquisition of Shares - Retired
In January 2007, Cooke Corp. purchased and cancelled 500 Class A shares at $4 per share. There are 10,500 shares issued and outstanding, with total share capital of $63,000
Common Shares (500 [$63,000/10,500] ) 3,000
Cash (500 $4.00) 2,000
Contributed Surplus 1,000
Assigned share value = $63,000/10,500 = $ 6.00
Acquisition cost = per share price/cost
Value over assigned value $2.00

34. Items Affecting Retained Earnings
DEBITS
Net loss
Prior period adjustments, accounting principle changes
Cash, property, stock dividends
Treasury stock
CREDITS
Net Income
Prior period adjustments, accounting principle changes
Adjustments from financial reorganization

35. Formality of Profit Distribution
No amounts may be distributed unless corporate capital is maintained intact
Under the CBCA:
There needs to be sufficient capital after the dividend to pay liabilities as they are due
The realizable value of the corporate assets does not fall below the total of the liabilities and the stated and legal capital for all classes of shares
Formal approval of the Board of Directors required
Dividends are in full agreement with share capital contracts
Before declaration of a dividend, management should consider availability of funds to pay the dividend

36. Dividend Distributions
Types of dividends
Return on capital
Cash dividend
Stock dividend
Return of capital
Liquidating dividends
Important dates
Date of declaration
Date of record
Date of payment

37. Cash Dividends First journal entry is on Date of Declaration
Dividend becomes legal obligation of the corporation
Equity account is debited, liability account is credited
Cash Dividends Declared
(or Retained Earnings) xxx Dividends Payable xxx
On Date of Payment liability is reduced

38. Cash Dividends
Before the dividend is paid, a current list of shareholders needs to be prepared (as at the date of record)
If a Cash Dividends Declared account is used rather than Retained Earnings at the date of declaration, this account is closed to Retained Earnings at year end

39. Dividends in Kind
Dividends payable in corporation assets other than cash
These dividends are normally measured at the “fair value” of the asset given up
Fair value is determined by referring to: estimated realizable value of same or similar assets, quoted market prices, independent appraisals

40. Stock Dividends No assets distributed (unlike cash dividends)
Unlike with cash dividends or dividends in kind, total shareholders equity does not change
Amounts are “re-arranged” as a result of the stock dividend
The transaction is measured at the fair value of the shares at declaration date
Each shareholder has the exact same proportionate interest in the corporation
However, book value per share decreases

41. Stock Dividends 1,000 common shares outstanding
Retained earnings = $50,000
10% stock dividend declared
Fair (market) value of share = $130 per share
Stock Dividends Declared 13,000
Common Shares ,000
1,000 x 10% =
Fair value $
Total $13,000

42. Dividend Preferences Example Data $50,000 total declared as dividends
Common share capital = $400,000
Preferred shares: 1,000 $6 outstanding (issued at $100,000)

43. Non-cumulative If shares are non-cumulative and non-participating
Dividends are distributed only when declared, up to the stated amount of the share
No amount is paid for years where dividends were not declared
Referring to previous data:
Preferred Shareholders are paid $6,000
($6 x 1000) and
Common Shareholders are paid the remaining amount of $44,000

44. Cumulative
If the preferred shares are cumulative and non-participating, and dividends not paid to the preferred shareholders in previous 2 years:
Preferred Shareholders are paid $18,000
( ($6 x 1000 x 2) + $6,000)
Common Shareholders are paid the remaining $32,000 ($50,000 - $18,000)

45. Participating
If no specific participation agreement exists, participation generally follows these guidelines
Following assignment to preferred shares of current year dividends (any cumulative dividends have been allocated first); common shares receive an amount to give them the same return rate as the preferred
Any remaining dividend amount is shared by both preferred and common in proportion to the carrying value of each share class

46. Participating
If preferred shares are non-cumulative and fully participating, using the previous data:
Preferred Common
Current year’s:
Preferred ($6 x 1000) $6,000
Common (6% x $400,000) $24,000
Remaining $20,000 at a
rate of $20,000/$500,000 (i.e. 4%):
Preferred (4% x $100,000) $4,000
Common (4% x $400,000) $16,000
TOTAL $10, $40,000

47. Stock Dividends vs. Stock Splits
As form of dividend must follow the requirements of a dividend
Both the number of shares, and the amount of share capital are affected
Shares are not exchanged
Stock Split
Increases the number of shares outstanding
Amount of share capital is not affected
Results in a market price manipulation

48. Components of Shareholders’ Equity
Contributed Surplus transactions
Par value share issue and/or retirement
Liquidating dividends
Financial reorganization
Stock options and warrants
Issue of convertible debt
Share subscriptions forfeited
Donated shares
Redemption or conversion of shares

49. Components of Shareholders’ Equity
Accumulated Other Comprehensive Income
Cumulative change in equity from non-shareholder transactions which are excluded from net income
Considered to be earned income

50. Disclosure of Share Capital
Per CICA Handbook, Section 3240, the following disclosure is required:
Authorized share capital
Issued share capital
Changes in share capital since last balance sheet date
May be disclosed in the notes to the financial statements, or in the body of the Balance Sheet

51. Disclosure of Share Capital
Note disclosure will contain the following information:
Authorized number of shares (if no limit, then so stated)
The existence of unique rights
Number of shares issued, and the amount received
Whether the shares are par-value or no-par value
Amount of any dividends in arrears for cumulative preferred shares
Changes during the year, including new issuances and redemptions
Restrictions on retained earnings

52. Shareholders’ Equity Ratios
Rate of return on common shareholders’ equity Net income – Preferred dividends Average common shareholders’ equity
Payout ratio Cash Dividends Net income – Preferred dividends
Price earnings ratio Market price per share Earnings per share
Book value per share Common shareholders’ equity Number of outstanding shares

53. International
IAS requires a separate statement for changes in all equity accounts
Canadian GAAP only requires separate retained earnings statement

54. COPYRIGHT
Copyright © 2007 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.