Download Chapter 1: Financial Accounting and Standards

INTERMEDIATE
ACCOUNTING
Sixth Canadian Edition
KIESO, WEYGANDT, WARFIELD, IRVINE, SILVESTER, YOUNG, WIECEK
Prepared by
Gabriela H. Schneider, CMA; Grant MacEwan College
CHAPTER
16
Shareholders’ Equity:
Contributed Capital
Learning Objectives
1. Discuss the characteristics of the corporate form of
organization.
2. Identify the rights of shareholders.
3. Explain the key components of shareholders’ equity.
4. Explain the accounting procedures for issuing
shares.
5. Identify the major reasons for repurchasing shares.
Learning Objectives
6. Explain the accounting procedures required for
reacquiring, retiring, and canceling shares.
7. Describe the major features of preferred shares.
8. Distinguish between debt and equity.
9. Identify items reported as contributed surplus.
10. Identify the major disclosure requirements.
Shareholders’ Equity
The Corporate
Form
Corporate
Capital
Preferred
Shares
Corporate Law
Issuance of shares
Features
Share capital
system
Reacquisition of
shares
Variety of
ownership
interests
Retirement of
reacquired shares
Special
presentation
issues
Limited liability of
shareholders
Formality of profit
distribution
Contributed Presentation
Surplus
and
Disclosure
Primary Forms of
Business Organization
Proprietorship
Engaged in making
financial returns for their
owners
Partnership
Corporation
Shares
privately held
Profit-oriented
Private
Sector
Not-for-profit
Public
Sector
Shares publicly
traded
No shares issued; created to
provide services for members or
society
Municipalities, Cities, Etc.
Crown
Created by government statute
to provide public services
Corporate Accounting
Special characteristics that impact on
accounting:
1. Corporate law
2. Share capital system
3. Development of a variety of ownership
interests
4. Limited liability of shareholders
5. Formality of profit distribution
Characteristics of the Corporate
Entity that Affect Accounting
• Corporate Law
• Canada Business Corporation Act (CBCA)
• Articles of incorporation prepared and submitted
• Company name
• Location of registered office
• Classes and authorized shares
• Directors
• Business restrictions
• CBCA regs. state that financial statements are to
be prepared in accordance with GAAP
Characteristics of the Corporate
Entity that Affect Accounting
• Use of Share Capital System
• Shares grouped by “class” (e.g. Class A Common)
• Each share contains certain rights and privileges
• Within each class, each share equal
• Variety of Ownership Interests
• Common shares vs. Preferred shares
• Different share types and classes appeal to
greater variety of investors
• Common shares
• Residual ownership interest
• Bear the greater risk
Characteristics of the Corporate
Entity that Affect Accounting
• Limited Liability of Shareholders
• Unlike partnership or proprietorship form of business
• Shareholders not generally liable for the obligations
of the corporation
• Formality of Profit Distribution
• No amounts may be distributed unless corporate capital is
maintained intact
• Sufficient capital remains after the dividend to pay
liabilities as they are due
• The realizable value of the corporate assets does fall
below the total of the liabilities
• Formal approval of the Board of Directors required
• Dividends are in full agreement with share provisions
The Rights of Shareholders
The shareholders have the right to:
1. Share proportionately in profits and
losses
2. Share proportionately in management
3. Share proportionately in corporate assets
upon liquidation
4. Share proportionately in any new issues
of stock of the same class (preemptive
right)
Shareholders’ Equity
• Shareholders’ equity is represented by:
• Amounts contributed by shareholders
• That portion of the assets retained by the
enterprise which are retained by the corporation
• When classifying liabilities and equities one
must look at the substance of the financial
instrument, rather than the legal form (i.e.
Redeemable Preferred Shares)
Components of
Shareholders’ Equity
Share Capital
Contributed
Surplus
Retained
Earnings
Contributed
Capital
Earned
Capital
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)
• Accounting definition of capital
• Shareholders’ equity which includes:
• Share capital (the legal/stated capital as defined above)
• Contributed surplus (equity transactions not specifically
included elsewhere)
• Retained earnings (all undistributed income that remains
invested in the business)
Major Sources of Changes in
Shareholders’ Equity
All Transactions and Events That Cause
Changes in Shareholders’ Equity
Net Income
Revenues
&
Expenses
Gains
and
Losses
Transfers Between Entity and
Owners
Investments
by Owners
Distributions
to Owners
Accounting for the
Issuance of Shares
• Shares basic
• Shares sold on a subscription basis
• Shares issued in combination with other
securities
• Shares issued in non-monetary
transactions
• Accounting for costs related to issuance
Shares Issue - Basic
• The full amount of the proceeds received
is credited to the respective share capital
account (preferred/common/class type)
1000 shares are sold for $2.00 each (issuance costs
are not included in this transaction). The journal
entry is:
Cash
2,000
Share Capital
2,000
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 price is paid and the
contract is settled
• Dividends may be attached to some
subscription shares, once the initial
payment is received
Shares Sold by Subscription
Accounts involved 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
Shares Sold by Subscription
• If a subscription contract is defaulted there are
generally three possible consequences:
• Funds paid to date are forfeited, with no refund or
shares being issued; balance of the contract is
cancelled
• Funds paid to date are refunded, often with a
deduction, and the balance of the contract is cancelled
• Shares are issued for the amount paid to date, with
the balance of the contract cancelled
Shares Sold by Subscription
1000 shares are sold on subscription for $10.00
each. 20% is due as initial payment.
The initial journal entries would be:
Subscription Receivable
Shares Subscribed
Cash
10,000
10,000
2,000
Subscription Receivable
2,000
Shares Sold by Subscription
If all payments are made as scheduled, the
entries would be:
Cash
8,000
Subscription Receivable 8,000
Shares Subscribed
Share Capital
10,000
10,000
If the subscriber defaults, one of the following
may happen (depending on the contract terms
and applicable legislation).
Shares Sold by Subscription
Default after first payment – funds held by
corporation.
Shares Subscribed
10,000
Subscription Receivable 8,000
Contributed Surplus
2,000
Shares Sold by Subscription
Default after first payment – funds refunded with a 20%
penalty charge.
Shares Subscribed
Cash
10,000
1,600
Contributed Surplus
Subscription Receivable
400
8,000
Default after first payment – shares issued for amount paid.
Shares Subscribed
10,000
Share Capital
2,000
Subscription Receivable
8,000
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
Shares Issued
With Other Securities
• Proportional method
• When the FMV is available for each class of
share involved
• The lump sum received is allocated between
the share classes sold on a proportional basis
Given:
1,000 common shares and 1,000 preferred shares
issued for a total of $30,000
Common share market value = $20.00 per share
Preferred share market value = $12.00 per share
Shares Issued
With Other Securities
First Step: Find the total market value of the shares
Common: 1,000 @ $20.00 =
$20,000
Preferred: 1,000 @ $12.00 =
12,000
Total Market Value
$32,000
Second Step: Allocate the total price proportional
based on the market values
Common: 20,000/32,000*30,000 =
$18,750
Preferred: 12,000/32,000*30,000 =
11,250
Total Allocation
$30,000
Shares Issued
With Other Securities
• Incremental method
• When the FMV is not available for all classes of
shares involved
• FMV may be available for some, but not all
share classes
• Use the FMV to allocate the funds for those
shares with the known FMV
• Remainder is allocated to the shares where the
FMV is not known
• If the FMV is not known for any of the share
classes, then an arbitrary method will have to be
used (this should be well documented)
Shares Issued
With Other Securities
Given:
1,000 common shares and 1,000 preferred shares
issued for a total of $30,000
Common share market value = $20.00 per share
Preferred share market value = Unknown
First Step: Allocate to the shares with the known FMV
Total Amount Received
$30,000
Allocate to Common (1,000*$20.00)
20,000
Balance Allocated to Preferred
$10,000
Shares Issued in
Non-Monetary Transactions
• Shares issued in exchange for nonmonetary goods or services
• Recorded at the FMV of the shares issued,
or the FMV of goods or services received
• CICA Handbook, Section 3830
Shares Issued in
Non-Monetary Transactions
• If FMV of both the goods/services and the
shares is known there should be little or no
difference in their respective FMV (based on
the transaction being at arms length)
• If FMV of neither the goods/services or the
shares is known the value will be determined
by management or the Board of Directors
(independent appraisal is the best tool to use
in this case)
Shares Issued in
Non-Monetary Transactions
• Use of historical values for establishing
FMV should be used with caution
• Watered stock: occurs when the value of
the goods/services received for the shares
is overvalued
• Secret reserves: occurs when the value of
the goods/services received is undervalued
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 deems these amounts to
be capital transactions and therefore should
not be included in net income calculation
• Accounting treatment - debit to Contributed
Surplus
Accounting for Share Issue Costs
Reduction of the amount paid in
1000 shares sold for $10.00 each, with $500 in
issue costs
Cash
9,500
Contributed Surplus
Share Capital
500
10,000
Reacquisition of Shares
Reasons for the reacquisition of a corporation’s own shares
• Have enough shares on hand to meet employee stock option
contracts
• Reduce the shares outstanding to increase EPS
• Buy out a particular ownership interest
• Make a market in the company’s shares
• Reduce the operations of the business
• Meet the needs of a potential merger
• Change the debt-to-equity ratio
• Settle a debt
• Provide a kind of 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
Reacquisition of Shares
• Shares may be retired when reacquired
• May also (in limited circumstances and jurisdictions)
become Treasury Stock (see Appendix)
• In either case, the accounts affected are:
•
•
•
•
Share Capital
Contributed Surplus
Retained Earnings
Treasury Stock (for Treasury Stock only)
Reacquisition of Shares Retired
• Share capital is debited with the original issue or
assigned value only
• The difference is then allocated to:
• Contributed Surplus (to an amount up to any
contributed surplus created by the cancellation or
resale of the same class of share)
• Contributed Surplus (pro rata share of the portion of
contributed surplus resulting from other transaction)
• Retained Earnings
Contributed Surplus NEVER goes to a debit balance
Reacquisition of Shares Retired
In 1997, Glider Co. issued 100,000 of its 500,000
authorized common shares at $35 per share. In January
1998, Glider repurchased and retired 1,600 shares at $30
per share. Assume these are the only share transactions
the company has ever had.
Common Shares (1,600 x $35)
56,000
Cash (1,600 x $30)
Contributed Surplus-
48,000
Excess of Carrying Value over Reacquisition Cost
8,000
Preferred Share Characteristics
• Preference as to dividends
• Preference as to assets in the event of
liquidation
• Convertible into common shares
• Callable (redeemable) at the option of the
corporation
• Retractable at the option of the shareholder
• Nonvoting
Preferred Stock - Features
• Cumulative preferred stock
• Participating preferred stock
• Fully Participating
• Partially Participating
• Convertible preferred stock
• Callable preferred stock
• Redeemable preferred stock , not
equity
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
Disclosure of Share Capital
• Note disclosure will contain the following
information
• Authorized number of shares (if no limit then so stated)
• If any unique rights attached to share class, which
rights and to which shares
• Number of shares issued, and the amount received
• Whether the shares are par-value or no-par value
• Amount of any dividends in arrears
• Changes during the year, including new issuances,
redemptions and resale of treasury shares
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