Accounting Principles Second Canadian Edition Weygandt · Kieso · Kimmel · Trenholm Prepared by: Carole Bowman, Sheridan College CHAPTER 14 CORPORATIONS: ORGANIZATION AND SHARE CAPITAL TRANSACTIONS CORPORATE FORM OF ORGANIZATION A corporation is a legal entity created by law that is separate and distinct from its owners CLASSIFICATION OF CORPORATIONS A corporation’s purpose may be to earn a profit, or it may be organized as non-profit Classification by ownership distinguishes between publicly-held corporations and privately-held corporations CHARACTERISTICS Separate legal existence Limited liability of shareholders Transferable ownership rights Ability to acquire capital Continuous life Corporation management Government regulations Additional taxes ILLUSTRATION 14-1 ADVANTAGES AND DISADVANTAGES OF A CORPORATION 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 ORGANIZATION COSTS Costs incurred in forming a corporation are called organization costs These costs include fees to underwriters, legal fees, incorporation fees, and promotional expenditures Organization costs are normally expensed in the year the organization cost is incurred SHAREHOLDER RIGHTS To raise capital, the corporation sells shares If only one class of shares-common shares Ownership rights specified in articles of incorporation or by-laws – Voting…owners SHARE TERMINOLOGY Authorized shares – maximum amount of shares a corporation is allowed to sell as authorized by corporate charter Issued shares – number of shares sold SHARE ISSUE CONSIDERATION How many shares should be authorized for sale? How should the shares be issued? At what price should the shares be issued? What value should be assigned to the shares? REACQUIRED SHARES Reacquired shares are a corporation’s own shares that have been issued, fully paid for, and then reacquired by the corporation Reacquired shares are generally retired and cancelled In certain restricted circumstances, these shares are not retired, but are held as treasury shares for later reissue REACQUISITION OF SHARES Why would a company choose to reacquire its shares? – Reduce quantity/raise share price – Increase EPS – If authorized share limit reached, may need additional shares for use in bonus or compensation plans or acquisitions PREFERRED SHARES Preferred shares have priority over common shares with regards to: Dividends and Assets in the event of liquidation Preferred shareholders usually not have voting rights Preferred shares are shown first in the share capital section of shareholders' equity PREFERRED SHARE PREFERENCES Liquidation preference Cumulative (dividends in arrears) Convertible (book value) Redeemable/callable (company option) Retractable (shareholder option) DIVIDEND PREFERENCES CUMULATIVE DIVIDEND A cumulative dividend requires that preferred shareholders be paid both current and prior year dividends before common shareholders receive any dividends Preferred dividends not declared in a given period are called dividends in arrears Dividends in arrears are not considered a liability, but the amount of the dividends in arrears should be disclosed in the notes to the financial statements CONVERTIBLE PREFERRED SHARES Convertible preferred shares allow the exchange of preferred shares into common shares at a specified ratio This kind of share is purchased by investors who want the greater security of a preferred share, but who also desire the added option of conversion In recording the conversion, the book value of the preferred shares is used The conversion of preferred shares does not result in either gain or loss to the corporation The market value of the shares is not considered REDEEMABLE PREFERRED Redeemable (callable) preferred shares grant the issuing corporation the right to purchase the shares from shareholders at specified future dates and prices This call feature allows some flexibility to a corporation by enabling it to eliminate this type of equity when it is advantageous to so While convertible shares are for the benefit of the shareholder, redeemable shares are for the benefit of the corporation RETRACTABLE PREFERRED Retractable preferred shares are similar to redeemable preferred shares except that the shareholder can redeem shares at their option instead of the corporation’s Retractable preferred shares and debt have many similarities Both offer a rate of return to the investor, and with the redemption of the shares they both offer a repayment of the principal investment Retractable preferred shares are presented in the liability section of the balance sheet rather than in the equity section because it has more of the features of debt than equity REMINDERSTATEMENT PRESENTATION OF SHAREHOLDERS’ EQUITY In the 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: Share capital Additional contributed capital ILLUSTRATION 14-10 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 BOOK VALUE PER SHARE Book value per share represents the equity a common shareholder has in the net assets of the corporation from owning one share The formula for calculating book value per share when a corporation has only one class of shares is: Total Shareholders ’ Equity ÷ Number of Common Shares = Book Value per Share CALCULATION OF BOOK VALUE WITH PREFERRED SHARES When a company has both preferred and common shares, the calculation of book value is more complex Steps required are: Calculate the preferred shareholders’ equity (the sum of redemption price of preferred shares plus any cumulative dividends in arrears) Determine the common shareholders’ equity (total shareholders’ equity less preferred shareholders’ equity) Divide common shareholders’ equity by the number of common shares to determine book value per share BOOK VALUE VS MARKET VALUE Book value per share seldom equals market value Book value is based on historical costs; market value reflects the subjective judgement of thousands of shareholders and prospective investors about the company’s potential for future earnings and dividends Market value per share may exceed book value per share, but that fact does not necessarily mean that the shares are overpriced COPYRIGHT Copyright © 2002 John Wiley & Sons Canada, Ltd All rights reserved Reproduction or translation of this work beyond that permitted by CANCOPY (Canadian Reprography Collective) is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd The purchaser may make back-up copies for his / her own use only and not for distribution or resale The author and the publisher assume no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the .. .CHAPTER 14 CORPORATIONS: ORGANIZATION AND SHARE CAPITAL TRANSACTIONS CORPORATE FORM OF ORGANIZATION... capital Continuous life Corporation management Government regulations Additional taxes ILLUSTRATION 14- 1 ADVANTAGES AND DISADVANTAGES OF A CORPORATION Advantages Corporate management professional... retain legal capital No-par value has NO relationship to market value once issued ILLUSTRATION 14- 5 RELATIONSHIP OF PAR, NO PAR AND STATED VALUE SHARES TO LEGAL CAPITAL Shares Legal Capital per