2. FINANCING: Part 3A: Equity CHAPTERS 13-16

3. CORPORATIONS Kinds Profit or non-profit Publicly-held, or privately held Sole Proprietorship PartnershipCorporation Service Merchandise Manufacturing

4. CORPORATIONS From Grade 11 A corporation is a person It is a legal entity that is separate and distinct from its owners The shareholders own the corporation; the corporation owns the assets. Own The Legal Entity of the Corporation Owns

5. Remits wealth The Legal Entity of the Corporation Make profit CORPORATIONS From Grade 11 Likewise, as separate legal entities, corporations and their owners are taxed separately. TAX (Dividends)

6. CORPORATIONS Characteristics – From Grade 11 Separate legal entity Have shares which represent ownership Common shares come with voting rights Limited liability of shareholders Transferable ownership rights Ability to acquire capital more easily Continuous life Management can be separate from owners Government regulations (lots) Possibility of double taxation

7. Advantages Disadvantages Corporate management - professional managers Separate legal existence Limited liability of shareholders Deferred or reduced income taxes Transferable ownership rights Ability to acquire capital Continuous life Corporation management - ownership separated from management Increased costs and complexity to adhere to government regulation Potential for additional income taxes CORPORATIONS Characteristics – From Grade 11

8. CORPORATIONS Organization Costs Costs incurred in forming a corporation are called organization costs. Organization costs are normally expensed in the year the organization cost is incurred.

9. CORPORATIONS Shares – The Basics To raise capital, a corporation sells shares Several types, but always common (voting) shares Authorized shares –Total number of shares allowed to be sold (as authorized by corporate charter). Issued shares –Total number of shares actually sold and outstanding.

10. CORPORATIONS Shares – Stock Market Price Shares of publicly held companies are traded on stock exchanges According to Capital Market Theory, just like bonds, share prices are determined by two factors: 1.The NPV of expected future cash flows from business operations (discounted to the present) 2.Supply and demand for the stock.

11. SharesLegal Capital per Share CORPORATIONS Shares - Par, No Par And Stated Value Par value No par value Entire proceeds Stated value A Corporation must retain legal capital. Note: Legal capital has NO relationship to market value once issued.

12. CORPORATIONS Shares - Par, No Par And Stated Value AccountPar or Stated ValueNo Par Share Accounts (Preferred or Common) Par or Stated Value goes in Entire proceeds go in Excess CapitalExcess over par or stated value goes in Nothing What goes into the Equity Accounts

13. Par value and Stated value – are assigned values given to issued shares. Originally they were required to ensure shares would always have some value. Their significance is now next to meaningless For No-par shares, legal capital equals the proceeds from issuing the stock to the public. CORPORATIONS Shares – Par Value, Stated Value, and No-Par Value

14. CORPORATIONS Statement of Shareholder’s Equity The shareholders’ equity section of a corporation’s balance sheet consists of: 1.Contributed capital (from proceeds from issue of shares) –Share capital (par or stated value) –Additional contributed capital (beyond par or stated value) 2.Retained earnings (profit retained in the business)

15. CORPORATIONS Statement of Shareholder’s Equity Shareholder’s Equity Contributed Capital Common shares: 2,000 $1 stated value shares, (50,000 authorized). Contributed capital in excess of stated value Total Contributed Capital Retained Earnings Retained Earnings, January 1 st Add: Net Income Less: Cash Dividends Change in Retained Earnings for the period. Retained Earnings, December 31 st Total Shareholder’s Equity 2,000 18,000 $30,000 $150,000 (80,000) 70,000 100,000 $130,000 Share Capital Additional Contributed Capital Note: when common shares have No-par value, the entire proceeds are legal capital, and are credited to Common Shares. Observe... DateParticularsDebitCredit July 31 Cash 20,000 Common Shares 20,000 Issued 2,000 no-par shares for $10 per share. When common shares have par value or stated value, this value is credited to “Common Shares” as you see here. Any proceeds beyond the stated value are credited to “Contributed Capital in Excess of Stated Value.” Observe… DateParticularsDebitCredit Sept 30 Cash 20,000 Common Shares (stated value only) 2,000 Contributed Capital in Excess of Stated Value 18,000 Issued 2,000 shares with a stated value of $1 per share for $10 each. Preferred Shares,$5 no par, cumulative (1,000 issued, 10,000 authorized). $10,000

16. Preferred shares have priority over common shares with regards to: 1. Dividends and 2.Any payments in the event of liquidation All dividends must be paid to preferred shareholders before common shareholders can receive anything (including past owed dividends) They can often be redeemable/callable/or convertible They usually don’t have voting rights CORPORATIONS Preferred Shares - Basics

17. 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

18. 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

19. 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. CALCULATION OF BOOK VALUE WITH PREFERRED SHARES

20. Do Problems: BE14-1 and BE14-10 E14-7 (no memo required) P14-4A (use T-accounts to post) P14-5A (you’ll have to read the text learn how to calculate this ratio when you have preferred shares)