Companies: Share Capital and the Statement of Financial Position

1. Companies: Share Capital and the Statement of Financial Position Chapter 14 HORNGREN ♦ HARRISON ♦ BAMBER ♦ BEST ♦ FRASER ♦ WILLETT

2. Objectives 1. Identify the characteristics of a company. 2.Record the issue of shares 3. Prepare the shareholders’ equity section of a company’s statement of financial position 4. Account for cash dividends 5. Use different share values in decision-making 6. Evaluate a company’s return on assets and return on shareholders’ equity 7. Account for the income tax of a company

3. Identify the characteristics of a company. Objective 1

4. Characteristics • separate legal entity • continuous life and transferability of ownership • no mutual agency • limited liability of shareholders • separation of ownership and management • company taxation • government regulation

5. Organising a company • The process of creating a company begins when the organisers (promoters) obtain a certificate of registration from ASIC. • The Corporations Act includes a number of basic rules for managing the company. • The company can accept these rules or replace them with their own company constitution.

6. Organising a company • Shareholders elect the board of directors. • The board sets policy, appoints the officers, and elects a chairperson. • The board also designates the managing director, who is often known as the chief executive officer (CEO).

7. Authority Structurein a Company Shareholders Board of Directors Chairperson of the Board Chief Executive Officer Various Executives and Company Secretary Controller? Treasurer?

8. Share Capital • Company ownership is evidenced by a ‘share certificate’ or ‘shareholder holding statement’ which may be for any number of shares. • See Exhibit 14-3 and 14-4 in your textbook • A share that is held by a shareholder is said to be an ‘issued share’.

9. Shareholders’ Equity Owners’ equity in the company has two components: Share capital Retained profits

10. Shareholders’ Equity Example On June 1, the Wong’s company issued share valued at $10,000. June 1 Cash 10,000 Share Capital 10,000 Issue of share

11. Shareholders’ Equity Example Wong’s company net profit for the year was $8,000. June 30 Profit and Loss Summary 8,000 Retained Profits 8,000 To close net profit to Retained Profits

12. Shareholders’ Rights • The ownership of share entitles shareholders to four basic rights, unless specific rights are withheld by agreement. • Vote • Dividends • Liquidation • Preemption

13. Classes of share • Ordinary share is the most basic form of capital share. • Preference share gives its owners certain advantages over ordinary shareholders. • In Australia shares are now issued without a par value (it makes the accounting easier).

14. Record the issue of shares. Objective 2

15. Issuing Shares Example • On January 13, Martin Limited, which manufactures skateboards, issues 10,000 ordinary share for $10 per share.

16. Issuing Shares Example The 10,000 shares were issued for $10 each. January 13 Cash 100,000 Ordinary Share Capital 100,000 Issue no par value ordinary share

17. Issuing Shares Example • On February 11, Martin company issued 15,000 shares of its ordinary share for a building worth $100,000. • What is the journal entry?

18. Issuing Shares Example February 11 Building 100,000 Ordinary Share Capital (15,000 shares)100,000 Issued ordinary share in exchange for a building

19. Issuing Shares ExampleBy Instalment • Shares may sometimes be issued by instalments. • Money may be payable: • When the investor makes applicationfor the shares. • When the shares are issued or the allotment made • Later when more money is asked for or a call is made

20. Issuing Shares ExampleBy Instalment • Huang Limited issues 10,000 shares • $5 payable on application • $3 on allotment and • $2 call.

21. Issuing Shares Example Applications received for 10,000shares Cash Trust (10,000 x $5) 50,000 Application 50,000 Received application money, to be held in trust

22. Issuing Shares Example The 10,000 shares were issued (allotted). Application (10,000 x $5) 50,000 Allotment (10,000 x $3) 30,000 Ordinary Share Capital 80,000 Issue ordinary share

23. Issuing Shares Example The application money is now ours, so it can be transferred from the trust account to our account . Cash 50,000 Cash Trust 50,000 Transfer application money to company’s bank account

24. Issuing Shares Example Received allotment money Cash 30,000 Allotment 30,000 Collected amount due on allotment

25. Issuing Shares Example Made the call and then received the money Call 20,000 Ordinary Share Capital 20,000 Called up balance outstanding on partly paid shares Cash 20,000 Call 20,000 Collected call on ordinary shares

26. Issuing Shares ExampleOversubscription • Investors may apply for more shares than are available to be issues. • If there is an oversubscription management may: • Refund the money or • Apply it to later amounts payable; allotment and or call. • Assume Huang received applications for 12,000 shares (12,000 x $5)

27. Issuing Shares Example Application 10,000 Cash Trust 10,000 Refund excess application money Or Application 10,000 Allotment 10,000 Apply excess application money to amount due on allotment

28. Issuing Shares ExampleForfeiture • Investors who do not pay the allotment or call may forfeit their shares. • Assume the holder of 100 Huang shares did not pay the call • The “Call” account was originally debited $20,000 • But only $19,800 cash was received

29. Issuing Shares Example To forfeit the shares Ordinary Share Capital (100 x $10) 300 Call (100 x $2) 300 Forfeited Share Account 700 Record forfeiture of 100 shares

30. Issuing Shares Example The forfeited shares were reissued for $9.50 each Cash 950 Forfeited Share Account 50 Ordinary Share Capital 1,000 Reissued 100 forfeited shares

31. Issuing Preference share • Accounting for preference share follows the pattern illustrated for ordinary share. • Shareholders’ equity on the statement of financial position lists, ordinary share, preference share, and retained profit – in that order.

32. Prepare the shareholders’ equity section of a company’s statement of financial position. Objective 3

33. Review of Accountingfor Paid-up Capital Shareholders’ Equity Contributed equity: 400 ordinary shares, fully paid 4,000 100 preference shares (70c per share annual dividend) fully paid 2,000 Retained profits 3,000 Total equity 9,000

34. Review of Accountingfor Paid-up Capital • Contributed equity and retained profits represent the shareholders’ equity (ownership) in the assets of the company. • Contributed equity comes from the company’s shareholders who invested in the company. • Retained profits come from the company’s customers – but has become the shareholders’.

35. Account for cash dividends. Objective 4

36. Dividend Dates • A company must declare a dividend before paying it. • The board of directors alone has the authority to declare a dividend.

37. Dividend Dates Three relevant dates for dividends are: Declaration date Date of record Payment date

38. Cash Dividends Example • On April 1, the board declares a dividend of $1 per share payable June 15 to shareholders of record on May 15. • There are 60,000 shares outstanding.

39. Cash Dividends Example April 1 Retained Profits 60,000 Dividends Payable 60,000 Declared a cash dividend June 15 Dividends Payable 60,000 Cash 60,000 Paid a cash dividend

40. Cash Dividends Example $50,000 dividends declared 1,000 Preference shares $6 annual dividend per share 25,000 Ordinary shares

41. Cash Dividends Example Preference dividend $6 × 1,000 = $6,000 Ordinary dividend $50,000 – $6,000 = $44,000

42. Cash Dividends Example Suppose there were 10,000 preference shares, $6 annual dividend per share Preference dividend $6 × 10,000 = $60,000 (The full $50,000 goes to preference shares) Ordinary shareholders receive nothing.

43. Cumulative and Non-cumulativePreference Shares • If the preference is cumulative, the $10,000 shortage must be paid before any dividend is paid to ordinary shareholders. • If noncumulative, a passed dividend not paid or not fully paid is simply lost.

44. Use different share values in decision-making. Objective 5

45. Share Values • The business community refers to different share values in addition to the original issue price. • market value • liquidation value • book value

46. Share Values Example Book value per share = Total shareholders’ equity ÷ Total shares outstanding Book value preference = (Liquidation value + Dividendsin arrears) ÷ Number of shares outstanding Book value ordinary = (Shareholders’ equity – Amount allocated to preference) ÷ Number of shares outstanding

47. Share Values Example Shareholders’ Equity Contributed Equity: Ordinary share, 10,000 shares, fully paid $300,000 Retained profits 100,000 Total shareholders’ equity $400,000 Book value per share: $400,000 ÷ 10,000 = $40

48. Share Values Example Book value per share preference: ($210,000 + $12,000) ÷ 2,000 = $111.00 liquidation + cumulative ÷ number = book value dividends shares value Book value per share ordinary: ($606,000 – 222,000) ÷ 10,000 = $38.40 (total equity – preference ÷ number = book book value) shares value

49. Evaluate a company’s return on assets and return on shareholders’ equity. Objective 6

50. Return on Assets Rate of return on total assets = Earnings before (interest + tax) ÷ Average total assets It is a measure of a company’s ability to generate profits from the use of its assets.