Chapter 10: Common Share Transactions

Question 1

What are the two types of shares issued by corporations?

Answer 1

Corporations issue common shares and preferred shares.

Question 2

What are common shares?

Answer 2

Common shares are the basic voting shares issued by a corporation and are often referred to as residual equity because they rank after the preferred shares for asset distribution upon liquidation of the corporation.

Question 3

What is the difference between common shares and preferred shares?

Answer 3

Preferred shares grant legal privileges or preferences that common shares do not have, such as priority in asset distribution upon liquidation.

Question 4

What is par value?

Answer 4

Par value is the nominal value per share established in the charter of a corporation. It has no relationship to the price at which shares are actually sold to investors.

Question 5

Why do most Canadian companies focus on no par value shares?

Answer 5

The CBCA and most provincial corporation acts prohibit the issuance of par value shares.

Most Canadian companies that still have par value shares outstanding issued them before the CBCA was amended in 1985.

Question 6

What was the original purpose of specifying a par value for shares?

Answer 6

The original purpose was to establish a minimum permanent amount of capital that the owners could not withdraw as long as the corporation existed, to protect creditors from the company’s bankruptcy.

Question 7

What is an initial public offering (IPO)?

Answer 7

An IPO involves the first sale of a company’s shares to the public and marks the transition from a private company to a public one.

Question 8

What is the difference between a primary market and a secondary market?

Answer 8

The primary market is where new issues of shares are sold to the public for the first time, and the secondary market is where existing shares are traded among investors.

Question 9

What are seasoned new issues or secondary share offerings?

Answer 9

These are additional sales of new shares to the public by a company that has already gone public.

Question 10

Who typically assists a company with an IPO?

Answer 10

An investment bank usually acts as an underwriter to assist in the sale of shares during an IPO.

Question 11

What is the accounting entry for issuing common shares for cash?

Answer 11

Debit Cash and credit Common Shares. For example, if a company issues 100,000 common shares for $60 per share, the entry would be a debit to Cash for $6,000,000 and a credit to Common Shares for $6,000,000.

Question 12

What happens to a corporation’s common share account when shares are issued to employees upon exercise of stock options?

Answer 12

The corporation’s common share account increases by the amount corresponding to the exercised stock options.

Question 13

What is a secondary market?

Answer 13

A secondary market is where investors who own shares from the initial public offering (IPO) may sell their shares to other investors.

The stock exchange acts as the secondary market.

Question 14

Are journal entries recorded for trades in the secondary market?

Answer 14

No, trades of shares among shareholders result in a transfer of funds and share ownership between them, but the accounts of the company issuing the shares are not affected.

Therefore, no journal entries are recorded.

Question 15

Which financial information service providers report on secondary market transactions?

Answer 15

Bloomberg.com, Reuters.com, finance.yahoo.com, and money.msn.com are some of the providers that report the results of millions of transactions among investors trading in all the global secondary markets.

Question 16

What is an IPO?

Answer 16

An IPO, or Initial Public Offering, is the first sale of shares to the public by a private company.

Question 17

Why might a company go public?

Answer 17

A company might go public to raise funds needed to expand and meet expected consumer demand or to create a market for its shares if it’s not listed on a major stock exchange.

Question 18

Are IPOs always safe investments?

Answer 18

No, while IPOs can offer good opportunities for excellent returns by investing in growing companies, there is substantial risk involved, and there are stories of both significant gains and losses in IPO investments.

Question 19

How do companies record the issuance of shares in exchange for non-cash assets or services?

Answer 19

When a company issues shares to acquire assets or services, the acquired items are recorded at the fair value of the assets or services received.

If the fair value cannot be reliably estimated, then the fair value of the shares would be used.

Question 20

What would be a journal entry for a company that issues shares in exchange for legal services?

Answer 20

The journal entry would debit legal fees and credit common shares by the value of the legal services received, which is assumed to be equal to the fair value of the shares issued.

Question 21

What is one advantage of the corporate form regarding equity ownership and management?

Answer 21

The corporate form allows the separation of the management of a business from its equity owners.

Question 22

Why might offering stock options to managers be beneficial for a corporation?

Answer 22

Stock options can align the interests of managers with those of the company by incentivizing managers to make decisions that will increase the value of the company in the long term.

Question 23

What is an exercise price in the context of stock options?

Answer 23

The exercise price is the predetermined contract price at which the holder of a stock option has the right to purchase shares in the future.

It is normally equal to the current market price per share when the option is granted.

Question 24

What is an Employee Stock Option Plan (ESP)?

Answer 24

An Employee Stock Option Plan (ESP) is a form of non-cash compensation that provides executives and employees the incentive to act in the best interests of the corporation, potentially increasing the company’s share price.

Question 25

How is the cost to a corporation determined when employees exercise their stock options?

Answer 25

The cost can be measured by using specific valuation methods to estimate the fair value of the options at the time of granting and then comparing the valuation with the exercise price to determine the additional compensation expense for the period.

Question 26

What must Canadian companies do with regards to the compensation expense associated with stock options?

Answer 26

Canadian companies must estimate and report the compensation expense associated with stock options on the statement of earnings.

Question 27

Why have some companies, especially in the technology, energy, and gold mining sectors, lobbied against reporting the cost of stock options as an expense on the statement of earnings?

Answer 27

These companies argue that reporting the cost of stock options as an expense lowers their net earnings and may turn net earnings into losses.

Question 28

What information does the BCE Annual Report’s Note 31 provide?

Answer 28

Note 31 provides information on share-based payments, detailing the stock options granted, exercised, forfeited, expired, and outstanding at the end of the year.

Question 29

What is one common reason a corporation may repurchase its shares?

Answer 29

To increase the market price per share and EPS that result from the reduction in the number of outstanding shares.

Question 30

What do most Canadian companies do with their shares after repurchase?

Answer 30

They cancel them.

Question 31

When a company repurchases shares, how is the share capital account adjusted?

Answer 31

It is reduced by an amount that reflects the average issuance price per share.

Question 32

What happens if the purchase price of repurchased shares is less than the average issuance price?

Answer 32

The difference is credited to contributed surplus.

Question 33

Using the example of BCE, how would you record the repurchase of 50,000 common shares at $50 each if the average issuance price is $54?

Answer 33

Debit Common Shares (Shareholders’ Equity) for $2,700,000.

Credit Cash (Asset) for $2,500,000.

Credit Contributed Surplus (Shareholders’ Equity) for $200,000.

Question 34

What is the journal entry effect on assets and shareholders’ equity when repurchasing shares at a price lower than the average issuance price?

Answer 34

Assets decrease due to cash outflow.

Shareholders’ Equity decreases due to the reduction in common shares and the increase in contributed surplus.

Question 35

How are repurchases of shares at prices lower than the average issue price categorized in financial statements?

Answer 35

They are capital transactions, not operating transactions.

Question 36

If BCE purchases 40,000 shares at $60 each when the average issuance price is $54, what is the excess of the purchase price over the average issuance price?

Answer 36

$6 per share for a total of $240,000.

Question 37

How is the excess purchase price over the average issuance price allocated in the journal entry?

Answer 37

It is debited first to contributed surplus to the extent of the account balance, and any remaining amount is debited to retained earnings.

Question 38

How does repurchasing shares above the average issuance price affect retained earnings?

Answer 38

Retained earnings are reduced because the excess of the purchase price over the contribution made previously by shareholders is considered a distribution of accumulated net earnings.

Question 39

What are the journal entry and transaction effects for BCE repurchasing 40,000 shares at $60 each?

Answer 39

Debit Common Shares (Shareholders’ Equity) for $2,160,000.

Debit Contributed Surplus (Shareholders’ Equity) for $200,000.

Debit Retained Earnings (Shareholders’ Equity) for $40,000.

Credit Cash (Asset) for $2,400,000.

Question 40

Can contributed surplus related to one class of shares be used for transactions involving a different class of shares?

Answer 40

No, contributed surplus related to one class of shares can only be used for share transactions involving the same class of shares.