INTERMEDIATE ACCOUNTING Seventh Canadian Edition KIESO, WEYGANDT, WARFIELD, YOUNG, WIECEK

1. INTERMEDIATEACCOUNTINGSeventh CanadianEditionKIESO, WEYGANDT, WARFIELD, YOUNG, WIECEK Prepared by: Gabriela H. Schneider, CMANorthern Alberta Institute of Technology

2. C H A P T E R 16 Shareholders’ Equity

3. Learning Objectives 1. Discuss the characteristics of the corporate form of organization. 2. Identify the rights of shareholders. 3. Describe the major features of preferred shares. 4. Explain the accounting procedures for issuing shares. 5. Identify the major reasons for repurchasing shares.

4. Learning Objectives • 6. Explain the accounting for reacquisition and retirement of shares. • Explain the accounting for various forms of dividend distributions. • Explain the effect of different types of dividend preferences. • Distinguish between stock dividends and stock splits.

5. Learning Objectives • Understand the nature of other components of shareholders’ equity. • Indicate how shareholders’ equity is presented. • Analyse shareholders’ equity. • Explain accounting for par value shares (Appendix 16A). • Explain accounting for treasury shares (Appendix 16A). • Describe the accounting for a financial reorganization (Appendix 16B).

6. Appendix 16B Reorganizations Comprehensive revaluation Shareholders’ Equity Retained Earnings Formality of profit distribution Types of dividends Stock splits Presentation and Disclosure Special presentation issues Statement of shareholders’ equity Corporate Form Corporate Law Share capital system Share Capital Types of shares Limited liability of shareholders Issuance Reacquisition Retirement Other Components Contributed surplus Other comprehensive income Perspectives Analysis Appendix 16A – Par Value and Treasury Shares Par value shares Treasury shares

7. Share Capital Common And/or Preferred shares Contributed Surplus Retained Earnings Components of Shareholders’ Equity Contributed Capital Earned Capital

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

9. 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)

10. Defining Capital Accounting definition of 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

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

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

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

14. 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

15. 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

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

17. Share Capital • Common shares • Represent basic 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

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

19. 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

20. Limited Liability • Limited Liability of Shareholders • Unlike partnership or proprietorship form of business • Shareholders not generally liable for the obligations of the corporation • Shareholders gains (“profit”) restricted to • Gain on the market price of their share • Dividends declared by the Board of Directors • Shareholders losses restricted to • Amount invested in the corporate shares

21. Accounting for the Issuance of Shares • Shares basic • Shares sold on a subscription basis • Shares issued in combination with other securities

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

23. 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

24. 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

25. 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, and the balance of the contract is cancelled • Funds paid to date are forfeited, 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

26. 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 5,000 Subscription Receivable 5,000

27. Shares Sold by Subscription If all payments are made as scheduled, the entries would be: Cash 5,000 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).

28. Shares Sold by Subscription Default after first payment – funds refunded with no penalty. Shares Subscribed 10,000 Accounts Payable (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

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

30. Share Subscription Exercise: E16-2 30,000 shares @ $20.00 Subscription terms: 30% down; balance in six (6) months Journal entries?

31. Share Subscription Exercise: E16-2 Share Subscription Receivable 420,000Cash 180,000 Shares Subscribed 600,000 (30,000 x $20.00) = $600,000 600,000 x 30% = $180,000 Record initial subscriptions and down payment received

32. Share Subscription Exercise: E16-2 Cash 420,000 Share Subscription Receivable 420,000Record receipt of the balance due on the subscription Shares Subscribed 600,000 Share Capital 600,000Record issuance of shares from subscription sale

33. 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

34. 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 and therefore should not be included in net income calculation • Accounting treatment—debit to Share Capital

35. 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 stock option 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

36. Share Repurchase • Other reasons may include: • Reduce the operations of the business • 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

37. 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)

38. 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 500 Share Capital 10,000

39. 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

40. Reacquisition of Shares - Retired In January 2005, Cooke Corp. repurchased and retired 500 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 shares@ $4.00) 2,000 • Contributed Surplus (500 @$2.00) 1,000 • Assigned share value = $63,000/10,500 = $ 6.00 • Acquisition cost = per share price/cost 4.00 • Value over assigned value $2.00

41. 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

42. 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 Items Affecting Retained Earnings

43. 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

44. 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

45. Cash Dividends • First journal entry is on Date of Declaration • Dividend becomes legal obligation of the corporation • Equity account is debited, liability account is creditedDividends Declared xxx Dividends Payable xxx • On Date of Payment liability is reduced

46. Stock Dividends • No assets distributed (unlike cash dividends) • Unlike with cash, or other asset, dividends, total shareholders equity does not change • Amounts are “re-arranged” as a result of the stock dividend • Amount transferred generally equal to the fair value at declaration date

47. 1,000 shares outstanding Retained earnings = $50,000 10% stock dividend declared Fair (market) value of share = $130 per share Stock Dividend Declared 13,000 Common Stock 13,000 1,000 x 10% = 100 Fair value $ 130 Total $13,000 Stock Dividend

48. Dividend Preferences Example Data • $50,000 total declared as dividends • Common share capital = $400,000 • Preferred shares: 1,000 outstanding 6% Share capital - $100,000

49. Non-Participating • 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

50. 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