Download Transactions Related to Shares

Accounting
Principles
Second Canadian Edition
Weygandt · Kieso · Kimmel · Trenholm
Prepared by:
Carole Bowman, Sheridan College
CH 14: CORPORATIONS:
ORGANIZATION AND SHARE
CAPITAL TRANSACTIONS
Ch 15: CORPORATIONS:
DIVIDENDS,
RETAINED EARNINGS, AND
INCOME REPORTING
Corporation Topics:
•
•
•
•
•
Types of Corporations
Classes of Shares
Transactions related to shares
Transactions related to dividends
Impact of different forms of dividends
on shareholder equity
• Corporate Financial Statements
Corporation Topics:
(additional details)
• Types of Corporations
– Public, Private, Not-for-Profit
• Classes of Shares
– Common, Preferred, Voting
Corporation Topics:
(additional details)
• Transactions related to shares
– Issues, buy backs, subscriptions
• Transactions related to dividends
– Declaration of
– Distribution of
Corporation Topics:
(additional details)
• Impact of different forms of dividends on
shareholder equity
– Cash Dividend effects
– Stock Dividend effects
– Stock Splits
• Corporate Financial Statements
– Income Statements
– Statement of Retained Earnings
– Shareholders’ Equity section of the Balance
Sheet
Types of Corporations
A corporation
is a legal entity created by law
that is separate and distinct from its owners
• A corporation’s purpose may be to earn a
profit, or it may be organized as not-forprofit.
• Classification by ownership distinguishes
between publicly-held corporations and
privately-held corporations.
Video Clip ….
Video Explanation: Youtube Link
Types of Corporations
• Public corporations are traded on a
stock exchange. Anyone can
purchase these stocks.
• Private corporations are not traded on a
stock exchange – they are not up for
public sale. Stocks are often owed by
the initial entrepreneur(s)
Types of Corporations
Advantages
•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
Disadvantages
•Corporation management ownership separated from
management
•Increased costs and complexity
to adhere to government
regulation
•Potential for additional income
taxes (double taxation – the
business pays tax on income as
do the shareholders)
Classes of Shares
• What are Stocks?
– Simply speaking, stock is a share in the
ownership of a company. Stock
represents a claim on the company's
assets and earnings. As you acquire
more stock, your ownership stake in the
company becomes greater. Whether you
say “shares”, “equity”, or “stock”, it all
means the same thing.
Classes of Shares
• Common Stock
–
–
–
–
majority of stock is this form
Represents share of ownership
One vote per share to elect directors/mgmt
Risk – common shareholders are last to be
paid out upon liquidation
• Preferred Stock
– Fixed dividend usually guaranteed
– No voting rights
– Less risky than common stock
– Callable – can be sold back at a premium
Another Class of Stock
• Companies may customize different classes of stock in
any way they want. The most common reason for this is
the company wanting the voting power to remain with a
certain group; hence, different classes of shares are
given different voting rights.
• Ex. one class of shares would be held by a select group
who are given ten votes per share, while a second class
would be issued to the majority of investors who are
given one vote per share.
• Usually designated as Class A and Class B.
• Ex. Berkshire Hathaway (ticker: BRK), the company of
Warren Buffett, has two classes of stock. "BRKa, BRKb"
or "BRK.A, BRK.B".
• These are called voting stock
Transactions Related to Shares
Some important terms to understand:
• Authorized Capital
This is the number of shares the company is permitted to
sell (set by the government) most corporations are granted
the right to sell an unlimited number of shares.
• Par Value Shares
Par value shares are shares in a company that has a
specific value as set out in its charter. The company does
not have to sell the stock for the par value but has to record
the value of stock sold at this value. For example, if Qwerty
Corporation sell 100 shares of $10 par value stock for $12
each, they would increase share capital by $1000 (100
shares x $10) and record the amount sold above par value
in a separate account. (SELDOM USED)
Transactions Related to Shares
• No Par Value Shares
These are shares with no specific value.
90% of issued stock is no par value stock
• Stated Value Stock
The board of directors may decide to give a
value to no par value stock. This is called the
stock’s stated value. It is recorded on the
books in the same manner as par value
stock. The difference is that management
has set the value, not the government.
Transactions Related to Shares:
Issuing Common Stock
• Common stock is sold: it is exchanged
for an asset (usually cash)
• Entry: debit the asset, credit the equity
account “Common Stock”
• Ex. PepsiCo. sells 400 shares at $30 each.
Cash (400*$30)
Common Stock
$12,000
$12,000
Transactions Related to Shares:
Issuing Common Stock
• If stock is sold for more than is stated value
(or par) value, the “excess” money is recorded
in a separate account
• Ex. If JR Inc. sells 10,000 shares of $5 stated
value common stock for $7 each, the entry
would be:
Cash
$70,000
Common Stock
Contributed Capital in Excess
of Stated (or par) Value
$50,000
$20,000
Transactions Related to Shares:
Issuing Common Stock
• A company may choose to issue shares for assets
or services. In order to satisfy the Cost Principle,
the value of the transaction must be recorded at
the fair market value of the asset or service.
• The debit is the asset acquired or the expense
paid
• If stated (or par) value exists, any extra value
must be accounted for
Transactions Related to Shares:
Reacquiring Common Stock
Companies may choose to buy back some of their stock.
they may do this:
• to reduce the number of outstanding shares and
increase the amount current shareholders earn
(earnings per share)
• to have additional shares available in case employees
have stock options in their contract
• to attempt to increase the market value of the stock by
reducing the number available
• If this happens, the entry is simply a reversal of the
entry to issue stock (DR Common Stock, CR Cash)
Transactions Related to Shares:
Common Stock Splits
• Carter Corp has issued 80 000 no par value common shares
with a value of $400 000. The market price of the stock has
constantly increased until it has reached $80 per share.
Management has decided to execute a stock split in order to
make the stock price more appealing.
• This is not a financial transaction because no accounts will
change in value. Accountants make a memorandum entry.
This just tells the reader what has happened.
• In the journal:
– Memorandum: Executed a 2 for 1 stock split increasing
the number of outstanding shares from 80 000 to 160
000
There is no change in value of the common stock
outstanding, just the number of the common stock
outstanding.
Transactions Related to Shares:
Common Stock Splits
Carter Corporation Shareholders'
Equity
Number of Common Shares Outstanding
Value of Common Share Outstanding
Market Price Per Share
Before
Stock
Split
After Stock
Split
80 000
160 000
$400 000
$400 000
$80
$40
Transactions Related to Shares:
Practice
1.
Watermelon Inc is authorized to issue an unlimited number
of no par value common shares. Show the entries for the
following:
a. Issued 2000 shares at $11 per share.
b. Issued 300 shares to the lawyer for a $2800 legal bill.
c. Issued 7000 shares for land with a fair market value of
$83 000.
d. Executed a 2 for 1 common stock split.
2.
Lemon Ltd is authorized to issue 50 000, $5 stated value
common shares. Show the entries for the following:
a. Issued 1000 shares at stated value.
b. Issued 200 shares at $7 per share.
c. Reacquired 500 shares at stated value.
Transactions Related to Shares:
Preferred Stock
• Same rules as common stock – however the
equity account used is “Preferred Stock”
• Preferred Stock includes Dividends
– expressed in a set amount per year (e.g. $5 per share)
or as a percent of the par or stated value (e.g. 4.5%
of par value).
– If a cumulative dividend stock (as most are), then the
dividend must be paid each year. If the company
cannot pay the dividend in one year, then the
amount accumulates and must be paid in future
years.
– No common shareholder dividends can be paid until
the preferred dividend is paid.
Transactions Related to Shares:
Preferred Stock
• Convertible Preferred Stock
– Means it can be converted to common stock
at a predetermined ratio
• Journal entry: DR Preferred Stock (reduces it),
CR Common Stock (increases it)
Transactions Related to Dividends
• A dividend is a distribution by a
corporation to its shareholders on a pro
rata (equal) basis.
• Dividends may be in the form of
– Cash
– Shares (normally common shares)
Transactions Related to Dividends:
Cash Dividends
• A cash dividend is a pro rata distribution
of cash to shareholders.
• For a cash dividend to occur, a
corporation must have:
1. retained earnings,
2. adequate cash, and
3. declared dividends
Transactions Related to Dividends:
Cash Dividends
• Three dates are important in connection with
dividends:
– Declaration date
• Entry: DR “Cash Dividend-Name of Stock” (equity
account being decreased) CR Dividends Payable (Liability
being increased)
– Record date
• No Entry needed – only registered owners on this date will
get the payment
– Payment date
• Entry: DR Dividends Payable, CR Cash
Transactions Related to Dividends:
Stock Dividends
• A stock dividend is a pro rata distribution of the
corporation’s own shares to its shareholders.
• A stock dividend results in a decrease in retained
earnings and an increase in share capital since a
portion of retained earnings is transferred to legal
capital.
• In most cases, the fair market value is assigned to the
dividend shares.
• Total shareholders’ equity and the legal capital per
share remain the same.
STOCK DIVIDEND EFFECTS
Shareholders’ equity
Common shares
Retained earnings
Total shareholders’ equity
Issued shares
Book value per share
Before
Stock Dividend
After
Stock Dividend
$500,000
300,000
$800,000
50,000
$ 16.00
$575,000
225,000
$800,000
55,000
$ 14.55
Stock dividends change the composition of shareholders’
equity because a portion of retained earnings is
transferred to contributed capital. However, total
shareholders’ equity remains the same. The number of
shares increases and this means that the book value per
share decreases.
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
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 climbs again
Corporate Financial Statements:
Income Statement
• There is no change in the income
statement for a corporation. Whether the
business is a service or merchandising
firm, the net income or net loss is
calculated the same way.
• However, The net income or net loss is then
transferred to the statement of retained
earnings.
Corporate Financial Statements:
Statement of Retained Earnings
• The statement of retained earnings is
completed as a support document for the
balance sheet.
• It details any increase (e.g. net income)
or decrease (e.g. cash dividend) in
retained earnings. An example follows…
Corporate Financial Statements:
Statement of Retained Earnings
King Corporation
Statement of Retained Earnings
for the year ended December 31, 2006
Balance, January 1, 2006
Add: Net Income (from Income Statement)
Less: Cash Dividends
Balance, December 31, 2006
$560 000
160 000
$720 000
300 000
$420 000
Corporate Financial Statements:
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 capital
2.
Additional contributed capital
SHAREHOLDERS’ EQUITY
PRESENTATION
ZABOSCHUK INC.
Partial Balance Sheet
Shareholders’ equity
Contributed capital
Share capital
$9 preferred shares, no-par value,
cumulative, 10,000 shares authorized,
6,000 shares issued
$ 770,000
Common shares, $5 stated value, unlimited shares
authorized, 400,000 shares issued
2,000,000
Total share capital
2,770,000
Additional contributed capital
Contributed capital in excess of stated value - common shares
860,000
Total contributed capital
3,630,000
Retained earnings
1,058,000
Total shareholders’ equity
$4,688,000
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