SHAREHOLDERS' EQUITY by gjjur4356

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									             SHAREHOLDERS’ EQUITY



The material on Shareholders’ Equity is covered in Chapter 14 of
the textbook.




                                                           1
TOPICS TO BE COVERED
SHARE CAPITAL
    PREFERRED SHARES
    COMMON SHARES
ISSUING SHARES
      NO PAR VALUE
      PAR VALUE
PAYMENT OF DIVIDENDS
    CASH DIVIDENDS
    STOCK DIVIDENDS
STOCK SPLITS
REACQUISITION OF SHARES


                          2
SHARE CAPITAL
• Share capital reports the amount invested by the shareholders to
purchase the shares when originally issued by the corporation
• Not affected by subsequent changes in the value of the stock
• Active investment by the owners


TYPES OF SHARES
      Preferred shares
      Common shares




                                                            3
Preferred shares - have preference over common shares (hence
the name!)
• dividends paid to preferred shareholders before common
shareholders receive any dividends
   • dividend rate stated either as a fixed dollar amount per share,
   or as a fixed percentage of the stated value of the share
• receive assets on liquidation of the corporation, after creditors
but before common shareholders
   • have a stated redemption value (say $100 per share) which
   is often referred to as a par or face value
   • on liquidation, preferred shareholders are entitled to receive
   the stated value
• market price of a preferred shares is determined by the stated
value and the dividend rate compared to market rates. (just like a
bond)                                                         4
Common shares - residual interest shares
•voting rights
   • right to elect the members of the Board of Directors
        • Board of Directors responsible for hiring CEO
• on liquidation of the corporation, the common shareholders have
the right to receive all assets that remain after the creditors and
preferred shareholders are paid in full (residual interest)
    • value of the common shares is based on the value of the
    corporation
    • if the corporation operates profitably and doubles in value,
    each common share will double in value - shareholders can
    receive their return by selling shares, if dividends are not paid
• No stated dividend rate on common shares
   • amount of dividends determined by the Board of Directors, at
   their discretion                                       5
• All shareholders, common and preferred, have the right to
receive audited financial statements
• All shareholders, common and preferred, have the right to
examine the records indicating the ownership of the shares,
transfers of ownership, and the minutes of shareholder meetings




                                                              6
For a privately held corporation, the rights of common and
preferred shares can be tailored to meet the owners’ needs
   • must always be at least one class of voting common shares
   • preferred shares may be voting or non-voting
   • common shares can be non-voting
   • preferred shares used for estate planning
EXAMPLE               Dad is ready to retire and Son is going to take
over the family business. Corporation is reorganized so that Dad
returns his common shares to the corporation in exchange for
preferred shares that are redeemable at an amount equal to the
fair market value of the business on that date (value of common
shares). New common shares are issued to Son for a nominal
value. Preferred and new common shares are voting. As the
corporation redeems the preferred shares, Dad gets his money
and Son obtains control.                                        7
PREFERRED SHARES - Additional characteristics that can be
attached to the shares through the terms set out in the Articles of
Incorporation of the business
• Non-voting - virtually all publicly traded preferred shares are
non-voting (shares are voting, unless specified otherwise)
• Cumulative dividend entitlement - dividends that are not
declared are in arrears and must be declared and paid before any
other dividends can be declared.
   • Preferred shares that do not have a cumulative dividend
   entitlement are non-cumulative - if dividends are not declared
   in the year, the shareholders never receive them
   • this is not an issue with common shares, as there is no fixed
   dividend amount


                                                               8
• callable (redeemable) - corporation can force the preferred
shareholders to sell their shares to the corporation at a value set
out in the Articles of Incorporation
   • call price normally higher than original issue price
       • 103 would indicate 103% of original issue price (stated
       value)
• retractable - the preferred shareholders can force the
corporation to buy back the preferred shares at a value set out in
the Articles of Incorporation
• convertible - preferred shares can be exchanged for common
shares at a specified ratio.
• Participating - preferred shares are entitled to extra dividends
above the stated dividend rate if common shareholders receive a
per share dividend that exceeds a stated amount.
                                                               9
ISSUING SHARES
• every text includes accounting for the issue of par value shares
   • corporations incorporated federally, in Manitoba and most
   other provinces CANNOT issue par value shares
   • par value is a stated or face value
      • par value usually reflected the original issue price of the
      shares, but as prices change to reflect the value of the firm,
      par value has no significance
      • difference between par value and actual issue price of
      shares creates a new equity account Contributed Surplus
• shares cannot be issued unless fully paid for
      • total issue price must be received first

                                                             10
AUTHORIZED SHARE CAPITAL
 The different classes or types of shares, and the number of
shares in each class, that the corporation may issue
   • The Articles of Incorporation may specify a specific number of
   authorized shares, or indicate the company is authorized to
   issue an unlimited number of shares in the class


ISSUED AND OUTSTANDING SHARES
• the number of shares sold (for cash or non-cash consideration)
and still held by shareholders
• most incorporation acts in Canada do not allow a corporation to
buy back its shares without canceling them, so that the number of
issued and outstanding shares are the same

                                                               11
ISSUING SHARES
• shares are recorded at the fair market value of the shares given
up or the assets acquired, whichever can be measured more
reliably
   • if no-par value shares are issued, the entire proceeds are
   credited to Share Capital - common (or preferred, as
   appropriate)
   • if par value shares are issued, par value per share x number
   of shares is credited to Share Capital - common, and the
   excess is credited to Contributed Surplus - issue of common
   shares




                                                            12
EXAMPLE         Newco Inc. has two classes of authorized shares,
Class A common shares, no par value, and Class B common
shares, par value of $20 per share. During 2000, Newco issued
20,000 Class A common shares for equipment with a fair market
value of $60,000 and inventory with a fair market value of
$20,000. In addition, Newco issued10,000 shares of Class B
common at $50 per share, received in cash.
Required: Prepare the journal entries to record the shares issued
in 2000.
Equipment                               $60,000
Inventory                                20,000
      Class A Common shares                          $80,000
Cash                                    $50,000
       Class B Common shares                         $20,000
       Contributed Surplus - issue of Class B         30,000
                                                          13
DIVIDENDS
• Distribution of after-tax profits to the owners of the corporation
   • NOT an expense of the business, not recorded on Income
   Statement
   • Paid out of Retained Earnings - cannot create a debit
   balance in Retained Earnings
• Dividend may be paid in
   • cash or other assets
   • additional shares issued to the shareholders
•CORPORATIONS DO NOT HAVE A LEGAL OBLIGATION TO
PAY DIVIDENDS (unlike obligation to pay interest on debt)
   • Dividends are only payable if the Board of Directors declares
   a dividend
                                                                14
IMPORTANT DATES RE: DIVIDENDS
Declaration date
The date the board of directors declares a dividend -creates a
liability
Date of record
The date when ownership is fixed for determining the right to
receive a dividend.
Payment date
The date when dividends are paid.




                                                            15
RECORDING DIVIDENDS
• when cash dividends are declared, they are recorded at the
amount of cash to be paid
   • assets and shareholders’ equity are reduced by the amount
   of the dividend




                                                           16
Stock dividends declared
  • if the number of shares issued is low enough that the market
  price of the shares is not changed significantly, the dividend is
  recorded at the fair market value of the stock on the date the
  dividend is declared (general rule < 25% stock dividend)
  • if the number of shares issued is so large that the price of the
  shares drops, the stock dividend is accounted for as a stock
  split
  • stock dividends do not change total assets or total
  shareholders equity
     • retained earnings are transferred into share capital
  • the shareholder’s ownership interest remains unchanged
  after a stock dividend
     • if a shareholder owned 10% before the stock dividend, he
     or she will own 10% after the stock dividend.       17
Cooney owns 1,000 common shares of the Tawny Corp.
There are a total of 20,000 shares outstanding.

                        Tawny Corp.
                       Balance Sheet
                     December 31, 1997

Assets   $340,000       Liabilities         $120,000
                        S/H Equity
                        Common shares        160,000
                        Retained earnings     60,000
          $340,000                          $340,000

December 31/97 Tawny Corp. declared a stock dividend of 1
share for every 10 held (10% stock dividend). Cooney was
delighted.
                                                       18
Required:   Determine the benefit of the dividend to Cooney.



SOLUTION: Tawny Corp.

Before stock dividend

Net assets ($340,000 - $120,000) =    $ 220,000
Shares outstanding                       20,000

Book value per share      $220,000 =        $11
                            20,000

Book value owned by Cooney       1,000 x $11 = $11,000


                                                          19
After stock dividend:
Net assets (unchanged as no assets were distributed) $220,000
Shares outstanding - before dividend    20,000
      Stock dividend - 10 %               2,000
                                         22,000
Book value per share                   $       10


Book value owned by Cooney
Shares before stock dividend              1,000
Shares received from stock dividend - 10%   100
                                          1,100
Book value per share                       x   $10
                                           $11,000
NOTE: Cooney’s share of net assets is unaffected by the stock
                                                          20
EXAMPLE - declaration of dividends
Sona Limited has three classes of shares Preferred Class A,
Preferred Class B and Common. In 1998, the company had a
loss and decided not to pay any dividends. In 1997, dividends
were declared and paid on all classes of shares. A partial
Balance Sheet at December 31, 1998 showed the following
information:
SHARE CAPITAL
Class A Preferred, 2,000 issued and outstanding,
      $5 cumulative dividend                         $200,000
Class B Preferred, 5,000 issued and outstanding,
      stated value of $50 per share,
      7% non-cumulative dividend                      250,000
Common, 30,000 issued and outstanding                 185,000
RETAINED EARNINGS                                    $289,000
                                                          21
On July 1, 1999 the company declared and issued a 10% stock
dividend on the common shares. The market price of these
shares on July 1 was $50 per share. On December 31, 1999, the
company declared and paid a $1 dividend on the common shares.
Also, the preferred shareholders received their dividend
payments for 1999. Net income for 1999 was $360,000, before
the tax reassessment below was recorded.

Also on December 31, 1999 the company was required to pay
income taxes for 1990 from a reassessment started and
completed in 1999. The amount owing was $140,000, which was
paid in full in cash.

REQUIRED: (SHOW ALL CALCULATIONS)
1.    Record all dividend entries for 1999.
2.    Prepare in proper format the Statement of Retained
Earnings of Sona Limited at December 31, 1999.
                                                           22
SOLUTION - SONA LIMITED
July 1 stock dividend
   • no dividends can be paid to the common shareholders while
   there are dividends in arrears to the preferred shareholders
   • Class A preferred shares are cumulative
      • 2,000 shares x $5 = $10,000 dividends in arrears
   • Class B preferred shares are non-cumulative - no dividends
   in arrears
Retained earnings                          $ 10,000
      Dividends payable - Class A Preferred         $ 10,000
Retained earnings                          $150,000
      Stock dividend distributable                    $150,000
      30,000 shares x 10% x $50/share
                                                           23
When the cash is paid and share certificates distributed:
Dividends payable - Class A preferred          $ 10,000
      Cash                                             $ 10,000
Stock dividend distributable                   $150,000
      Common shares                                    $150,000


      December 31, 1999 dividend
Preferred Class A          2,000 shares x $5/share = $10,000
Preferred Class B          5,000 x 7% x $50/share = $17,500
Common shares          (30,000 + 3,000) x $1/share = $33,000
Class B shares - the dividend is calculated as a percentage of
stated value of the share $50 x 7% = $3.50 per share.
Another variation would be to give you the total dividends
declared and asked you to allocate the dividends to each class of
share.                                                      24
Retained earnings                         $ 60,500
      Dividends payable - Class A Pfd                $10,000
      Dividends payable - Class B Pfd                 17,500
      Dividends payable - Common                      33,000


      When cash dividends are subsequently paid:
Dividends payable - Class A Preferred     $ 10,000
Dividends payable - Class B Preferred       17,500
Dividends payable - Common                  33,000
      Cash                                            $60,500


Calculation of net income for 1999
      as stated                           $360,000
      income tax expense to be recorded   (140,000)
      Net income                          $ 220,000
                                                       25
                           Sona Limited
                  Statement of Retained Earnings
              for the year ended December 31, 1999

Retained Earnings, start of year            $ 289,000
Add: net income for the year                  220,000
                                              509,000
Less: dividends declared
       Stock dividends                        150,000
       Cash dividends - preferred              37,500
       Cash dividends - common                 33,000
                                              229,500
Retained earnings, end of year              $ 279,500




                                                        26
STOCK SPLIT
• issue additional shares to the existing shareholders
• in a four for one split, the shareholders would receive 4 shares in
exchange for each share held
• objective is to reduce the fair market value of the shares
   • an investor with $5,000 to spend does not want to spend the
   whole amount on one share. Companies normally want their
   shares to trade at an affordable price.
• Stock dividend in excess of 25% treated as a stock split


NOTE: a stock split has no effect on the general ledger accounts.
The only effect is to change the number of shares issued and
outstanding that is reported on the Balance Sheet.
                                                               27
REVERSE STOCK SPLIT
• reduces the number of shares outstanding
• in a 1 for 10 reverse stock split, a shareholder receives one
share for for every 10 shares owned
•one objective is to increase the fair market value of each share
   • if the company’s shares are trading at $.03 per share, a 1 for
   10 reverse stock split will raise the fair market value to $.30
   per share




                                                              28
REACQUISITION OF SHARES
When a corporation buys its own shares:
a) the corporation must calculate the average book value of the
class of shares being repurchased
b) the share capital account for the class of shares must be
reduced by the book value of the shares reacquired
c) any difference between the cash paid to reacquire the shares
and the book value of the shares CANNOT ever be reported as a
gain or loss on the Income Statement
   • if the cost is less than book value, Contributed Surplus is
   created
   • if the cost is greater than book value
        - Contributed Surplus is reduced, if it exists
        - Retained Earnings is reduced by the excess over
         Contributed Surplus                                   29
EXAMPLE
Thomas Book Enterprises Inc. reported the following information
on its Balance Sheet as of December 31, 1999:
Preferred shares, Class A, 4,000 issued,
cumulative dividend of $6 per share             $ 400,000
Common shares, 200,000 issued                    1,800,000


During March 2000, Thomas Book repurchased 2,000 common
shares on the stock market at a total cost of $12,000. During July
2000, Thomas Book repurchased 1,000 common shares at a total
cost of $22,000.
Required:
Prepare the journal entries to record the share transactions on
Thomas Book’s books during 2000.
                                                             30
SOLUTION
  COMMON SHARES
          1,800,000            total book value    1,800,000
                               total # of shares    200,000

                                      book value/share = $9


March share repurchase
      Book value of shares reacquired $9 x 2,000 = $18,000
      Cost to reacquire shares                      12,000
       increase to Contributed Surplus               6,000
Common shares                         $18,000
    Cash                                           $12,000
    Contributed Surplus                              6,000
                                                        31
    COMMON SHARES
            1,800,000          total book value    1,782,000
     18,000                    total # of shares    198,000
            1,782,000
                                      book value/share = $9


July share repurchase
      Book value of shares reacquired $9 x 1,000 = $ 9,000
      Cost to reacquire shares                      22,000
      Excess of cost over book value                13,000
       decrease to Contributed Surplus               6,000
       decrease to Retained Earnings                 7,000
Common shares                         $ 9,000
       Cash                                        $22,000
Contributed Surplus                     6,000
       Retained Earnings                             7,000
                                                        32
RATIO ANALYSIS
Return on Equity - one of the most popular ratios
            Net income - Preferred dividends
      Average common shareholders’ equity - book value


common shareholders’ equity = total shareholders’ equity less
preferred share capital at book value
average common equity = opening + closing common s/h equity
                                          2
Calculates the profit (or return) generated by each dollar invested
by the common share holder



                                                             33
BOOK VALUE PER SHARE


Total shareholders’ equity - book value of preferred shares
             # of common shares outstanding


• this figure is calculated for reacquisition of shares
• NOT a particularly meaningful ratio for evaluating a business
• Book value per share has absolutely NO relation to the fair
market value of a share.




                                                                34
PRACTICE QUESTIONS FROM CHAPTER 14
2, 3, 4, 5, 8, 10, 14, 17
E14-2, E14-4, E14-5, E14-6
P14-1, P14-4, P14-6, P14-7


CHAPTER 15 (yes I really mean 15)
E15-9




                                     35

								
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