Topic 10 equity PDF(1)

TOPIC 10 EQUITY PART 1: THE CORPORATION, SHARES, AND DIVIDENDS Topic 10 Learning Objectives (Part 1) On completion of this topic, you should be able to: Explain the business context and the importance of decision making relating to equity Identify and discuss the main characteristics of a corporation (company) Record the issue of ordinary shares Prepare the entries for cash dividends and share dividends and describe the impact on equity and assets CHARACTERISTICS OF A CORPORATION • Companies most common form of a corporation – private and public (listed and unlisted) • Company is a separate legal entity (unlike sole trader and partnership) where owners are referred to as shareholders and because of this… • Shareholders have limited liability • Companies have transferability of ownership rights and a continuous life • government regulation Forming 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 companies • The company can accept these rules or replace them with their own company constitution | SHAREHOLDER RIGHTS Three essential characteristics: • • • 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) | ISSUE OF SHARES • A company may issue shares by private placement • Public companies may also issue shares publicly • This requires a prospectus, which is a document reporting on the company’s financial position, performance and plans Accounting for a private placement KCeT P/L needs capital to expand her business and Kelly Cook’s uncle buys 20,000 shares at $1 each 1/07/2018 Cash 20,000 Share Capital 20,000 (record issue of 20,000 shares at $1 each) | ISSUE OF SHARES Accounting for a public issue On 15 July, Flight Central Ltd A public company needs capital to expand and invites the public to subscribe for 1,000 ordinary shares at $20 each: • $12 payable on application • $5 on allotment • $3 on call Applications close on September and directors will allot shares on 20 Sep and payment for allotment due by 30 September 2018 1/9/2018 Cash Trust (1,000 x $12) 12,000 Application 12,000 (Record receipt of application funds at $12 per share) 20/9/2018 Application Allotment Ordinary Share Capital 12,000 5,000 17,000 (Record issue of shares) 20/9/2018 Cash at Bank 12,000 12,000 Cash Trust (Record transfer of application money to company’s bank account) 30/9/2018 Cash at Bank Allotment 5,000 5,000 (Record collection of amount due on allotment - $5 x 1,000) | DIVIDENDS A dividend is a distribution of profit by a company to its shareholders on a pro rata basis Forms of dividends:  cash  Shares  property Public companies often pay dividends: • Final dividend determined at end of year • Interim dividend paid during the year On Dec 2018 Flight Central Ltd declares a cash dividend of $5 per share payable Dec 15 to shareholders of record on Dec There are 5,000 shares outstanding 1/12/2018 Retained Earnings 25,000 25,000 Dividends Payable (Record declared dividend) 15/12/2018 Dividends Payable Cash at Bank 25,000 25,000 (Record payment of cash dividend) | SHARE DIVIDENDS  Sometimes called bonus issues they are a distribution of own shares to shareholders  No assets are relinquished and they not change total shareholders’ equity Before After Bonus  A share dividend is a transfer of retained EQUITY Bonus Issue Issue Share Capital earnings to share capital (contributed 5000 Ordinary shares fully paid 100,000 100000 equity) 1500 Ordinary shares fully paid 30000  Same process & recording procedure as Retained Earnings 150,000 120000 cash dividends (declare, record & pay) TOTAL EQUITY 100,000 100,000 The current market price of Flight Central Ltd is $20 and on Jan 2018 the directors declare a bonus issue of 1,500 shares for shareholders of record on Jan for Jan 15 1/1/2019 Retained Earnings 30,000 30,000 Dividends Payable (Record declared ordinary share dividend from retained earnings) 15/1/2019 Dividends Payable 30,000 Share Capital 30,000 (Record issue of 1,500 ordinary shares in a share dividend) | Topic 10 Learning Objectives (Part 1) On completion of this topic, you should be able to: Explain the business context and the importance of decision making relating to equity Identify and discuss the main characteristics of a corporation (company) Record the issue of ordinary shares Prepare the entries for cash dividends and share dividends and describe the impact on equity and assets Topic 10 Learning Objectives – Part On completion of this topic, you should be able to: Identify components of comprehensive income and changes in equity including items that affect retained earnings Evaluate a company’s dividend and earnings performance from a shareholder’s perspective Evaluate debt and equity as alternative sources of finance EQUITY - REPORTING | 11 EQUITY - REPORTING Equity section includes: • Share capital: contributed equity (paid and any outstanding amounts) • Retained earnings: prior profits kept within company and not distributed as dividends • Reserves: changes in equity not created through transactions with owners Statement of Changes in equity • Reflects the net changes in equity accounts for the period • Must show for each equity account a reconciliation between opening and closing | balances 12 ANALYSING FINANCIAL STATEMENTS FOR DECISION MAKING DIVIDEND PAYOUT measures the percentage of profit distributed in the form of cash dividends to ordinary shareholders RETURN ON ORDINARY SHAREHOLDERS EQUITY measures profitability from the shareholders’ perspective | 13 DEBT vs EQUITY FINANCING DECISION MAKING Advantages & Disadvantages of DEBT • Finances profitable investment opportunities • Does not dilute ownership interests • Interest is tax deduction (a tax shield) • “Leverage” is the use of debt to increase return on investment for stockholders • Interest payments must be made before dividends • Increases financial risk (bankruptcy risk) Financing through EQUITY on the other hand…… • Is less risky • Creates no liabilities • Has no interest burden • But may dilute ownership interest Businesses can increase the return to their shareholders (ROE) by using debt, provided that the return they receive on their assets exceeds the | amount paid to service the debt 14 DEBT vs EQUITY FINANCING DECISION MAKING • Sista Limited, an internet retailer of raunchy women’s surf clothing has $1,000,000 in share capital and wants to expand into men’s surf wear and needs $500,000 to purchase Brosta • Sista’s CFO believes this acquisition will increase profits to $300,000 (before interest and income tax at a rate of 30%) • Sista Limited can either: • Borrow the required capital of $500,000 at 10% interest p.a OR • Issue 50,000 ordinary shares for $10 each to raise $500,000 Should Sista borrow the money or issue additional ordinary shares? | 15 DEBT vs EQUITY FINANCING DECISION MAKING • • • • Share capital before capital raising $1 million Purchase of Brosta estimated to increase profits before interest and tax to $300,000 Cost of debt finance 10% pa Tax payable at 30% Share Capital before capital raising Sell shares to finance investment in Brosta Total Equity Expected EBIT with Brosta Less Interest Expense (500,000 x 10%) Profit before tax $1,000,000 $500,000 $1,000,000 $1,500,000 $1,000,000 $300,000 $300,000 -$50,000 $0 $0 $250,000 Less Income Tax Expense @ 30% $300,000 -$90,000 Projected net profit $210,000 $175,000 14% 18% Total Equity -$75,000 | 16 Topic 10 Learning Objectives – Part On completion of this topic, you should be able to: Identify components of comprehensive income and changes in equity including items that affect retained earnings Evaluate a company’s dividend and earnings performance from a shareholder’s perspective Evaluate debt and equity as alternative sources of finance  ... the impact on equity and assets Topic 10 Learning Objectives – Part On completion of this topic, you should be able to: Identify components of comprehensive income and changes in equity including... perspective Evaluate debt and equity as alternative sources of finance EQUITY - REPORTING | 11 EQUITY - REPORTING Equity section includes: • Share capital: contributed equity (paid and any outstanding... $300,000 -$90,000 Projected net profit $ 210, 000 $175,000 14% 18% Total Equity -$75,000 | 16 Topic 10 Learning Objectives – Part On completion of this topic, you should be able to: Identify components