Chapter 10 Terms

Question 1

Privately-held shares

Answer 1

A privately-held corporation’s shares are not issued for sale to the general public.

Shares give partial ownership of a company.

Question 2

Publicly-held shares

Answer 2

Issued for sale to the general public. Sometimes held on a stock market like the Toronto Stock Exchange or the new York Stock Exchange.

Question 3

How is a corporation different from an individual?

Answer 3

• It is separately regulated by law,
• has an indefinite life,
• its owners have limited liability,
• it can usually acquire capital more easily than an individual.

Question 4

Classes of shares

Answer 4

The types of shares that the company is allowed to offer as decided in the legal documents when the company was created.

Question 5

Authorized shares

Answer 5

The quantity of shares that are allowed as stated in the legal documentation when the company is created.

Question 6

Certificate of Incorporation

Answer 6

In the creation of a company, this is the legal document that outlines the classes of shares and the authorized number (quantity) of shares that have been decided upon.

Question 7

How does voting for a Chief Executive Officer or President work in a corporation?

There are other names used for this title as well, but these are common.

Answer 7

A shareholder or group of shareholders who control more than 50% of the voting shares of a corporation are able to elect the board of directors and thus direct the affairs of the company. In a large public corporation with many shareholders, minority shareholders with similar ideas about how the company should be run sometimes delegate their votes to one person who will vote on their behalf by signing aproxystatement. This increases their relative voting power, as many other shareholders may not participate in shareholders’ meetings.

Question 8

General regulations for incorporated companies

Answer 8

It must provide timely financial information to investors.

It must file required reports with the government.

It cannot distribute profits arbitrarily but must treat all shares of the same class alike.

It is subject to special taxes and fees.

Question 9

How do you know a company has limited liability?

Answer 9

For the protection of creditors, the limited liability of a corporation must be disclosed in its name. The words “Limited,” “Incorporated,” or “Corporation” (or the abbreviations Ltd., Inc., or Corp.) are often used as the last word of the name of a company to indicate this corporate form. Corporations have limited liability by definition.

Question 10

The rights and privileges usually attached to common shares

Answer 10

The right to participate in the management of the corporation by voting at shareholders’ meetings (this participation includes voting to elect a board of directors; each share normally corresponds to one vote).

The right to receive dividends when they are declared by the corporation’s board of directors.

The right to receive assets upon liquidation of the corporation.

The right to appoint auditors through the board of directors.

Vote, dividends, assets, auditors

Question 11

pre-emptive right

Answer 11

right to maintain their proportionate interests in the corporation if additional shares are issued.

Question 12

Can shareholders back out of a company?

Answer 12

Yes if the following occurs:

If the corporation intends to make fundamental changes in its business, these shareholders can often require the corporation to buy their shares at their fair value. In addition, shareholders can apply to the courts for an appropriate remedy if they believe their interests have been unfairly disregarded by the corporation.

Question 13

Preferred shares

Answer 13

Preferred sharesis a class of share where the shareholders are entitled to receive dividends before common shareholders. These shares usually do not have voting privileges. Preferred shareholders typically assume less risk than common shareholders. In return, they receive only a limited amount of dividends. Issuing preferred shares allows a corporation to raise additional capital without requiring existing shareholders to give up control. Preferred shares are listed before common shares in the equity section of the balance sheet

Question 14

Status of shares

Answer 14

Question 15

EPS

Answer 15

The amount of net income earned in a year can be divided by the number of common shares outstanding to establish how much return has been earned for each outstanding share.

EPS =
Net income / Number of common shares outstanding

EPS is quoted in financial markets and is disclosed on the income statement of publicly-traded companies.

Earnings per common share

Notice that this does not include preferred shares.

Question 16

Debt financing advantages

Answer 16

Advantage 1: Earnings per share

Advantage 2: Control of the corporation

Advantage 3: Income taxes expense

Question 17

Debt financing Advantage 1: Earnings per share

Answer 17

This EPS is greater than the EPS earned through financing with either preferred shares or additional common shares. On this basis alone, the issue of debt is more financially attractive to existing common shareholders.

Question 18

Debt financing Advantage 2: Control of the corporation

Answer 18

If additional common shares were issued, there might be a loss of corporate control by existing shareholders because ownership would be distributed over a larger number of shareholders, or concentrated in the hands of one or a few new owners.

Question 19

Debt financing Advantage 3: Income taxes expense

Answer 19

Interest expense paid on debt is deductible from income for income tax purposes. Dividend payments are distributions of retained earnings, which is after-tax income. Thus, dividends are not deductible again for tax purposes.

Question 20

Disadvantages of debt financing

Answer 20

The interest expense is a fixed amount. It must be paid to creditors at specified times, unlike dividends.

Another disadvantage is the fact that debt must be repaid at maturity, whether or not the corporation is financially able to do so. Shares do not have to be repaid.

Question 21

Practice 10.1 page 8 activity

Answer 21

You couldn’t get the values to work in the first row but now you know how

Question 22

stated value of a share

Answer 22

the amount for which it is issued

Also called nominal value

Question 23

other name for stated value (shares)

Answer 23

nominal value

Question 24

other name for stated value (shares)

Answer 24

nominal value

Question 25

share par-value

Answer 25

the amount stated in the corporate charter below which shares cannot be sold upon initial offering

Question 26

In this course are we using stated value or par-value?

Answer 26

stated value will be assumed for all shares in this course

Question 27

Journal Entries to issue common shares

Answer 27

debit cash
credit common shares

to record the issuance of 1,000 common shares at $10 per share

Question 28

Journal Entries to issue common shares

Answer 28

debit cash
credit common shares

to record the issuance of 1,000 common shares at $10 per share

Question 29

Journal entries to issue preferred shares to the owner of land and buildings

Answer 29

debit land
debit building
credit preferred shares

To record the issuance of 2,500 preferred shares in exchange for land and buildings

Question 30

Journal entries to issue preferred shares to the owner of land and buildings

Answer 30

debit land
debit building
credit preferred shares

To record the issuance of 2,500 preferred shares in exchange for land and buildings

Question 31

Usually before a corporation is created, somebody or a few people will use their own funds to pay for legal and government fees, travel, and promotional costs. When the corporation is formed, shares are usually issued to this person or these people for these amounts. What are these expenditures called?

Answer 31

organization costs (start-up costs)

In journal entries it will be called organization expense

Question 32

What is the journal entry to compensate organizers of a company for their services by issuing common shares?

Answer 32

debit organization expense
credit common shares

to record the issuance of 500 common shares in exchange for organization efforts

Question 33

Headings for equity section of the balance sheet including preferred and common shares

Answer 33

Contributed capital
Preferred shares
Common shares
Total contributed capital (add value of preferred shares and common shares)

Retained earnings

Total Equity (add total contributed capital to retained earnings)

Question 34

Journal entry to repurchase common shares

Answer 34

debit common shares
credit cash

to record the repurchase of 200 common shares at $10 per share to be held in treasury

Question 35

Journal entry to record the repurchase of common shares at $9 per share instead of the issue price of $10 per share

Answer 35

debit common shares 1000
credit contibuted surplus, shares retirement 100
credit cash 900

to record the repurchase of 100 common shares at $9 per share

Question 36

Journal entry to record the repuchase of common shares at $9 per share instead of the issue price of $10 per share

Answer 36

debit common shares 1000
credit contibuted surplus, shares retirement 100
credit cash 900

to record the repurchase of 100 common shares at $9 per share

Question 37

Equity section of the balance sheet including contributed surplus

Answer 37

Contributed capital
Preferred shares
Common shares
Contributed surplus
Total contributed capital (add preferred shares, common shares, and contributed surplus)

Retained earnings

Total equity (add total contributed capital and retained earnings)

Question 38

Journal entry for repurchasing and cancelling common shares for $11 per share when the average issue price was $10 per share

Answer 38

Debit common shares
Debit contributed surplus (to reverse a previous thing that had a surplus since now there is no longer a surplus)
Debit retained earnings (to decrease earnings)
Credit cash

To record the repurchase of 150 common shares at $11 per share

Question 39

What is a share split

Answer 39

It increases the number of shares issued and outstanding, and lowers the cost of each new share. The originally-issued shares are exchanged for a larger number of new shares.

There is no increase to the total dollar amount of shares, so a journal entry is not required. A memorandum entry would be recorded in the general ledger instead to indicate the new number of shares issued and outstanding.

Question 40

Can dividends come from share capital?

Answer 40

No

Question 41

Where do dividends come from?

Answer 41

retained earnings

Question 42

What are considerations when choosing to declare dividends? What do the board of directors look out for?

Answer 42

Consideration 1: there may not be adequate cash
Consideration 2: a policy of the corporation may preclude dividend payments
Consideration 3: no legal requirement that dividends have to be paid
Consideration 4: dividends may be issued in shares of the corporation rather than in cash

Question 43

Consideration 1 when declaring dividends: lack of cash

Answer 43

• this happens since owners try to use the cash quickly to buy assets that will help them to make more profits

Question 44

Consideration 2: a policy of the corporation may preclude (prevent the occurance of) dividend payments

Answer 44

the corporation can possibly never pay dividends according to their policy they have in place

shareholders can still benefit through increased earnings since the market price of the corporation’s shares can rise

this type of policy is usually found in growth-oriented corporations

Question 45

Consideration 3: no legal requirement that dividends have to be paid

Answer 45

the board of directors may decide that no dividends should be paid since legally there is no requirement to do so

shareholders can then choose to elect a new board of directors or sell their shares if they don’t like this

Question 46

Consideration 4: dividends may be issued in shares of the corporation rather than in cash

Answer 46

share dividends may be issued to conserve cash or to increase the number of shares to be traded on the stock market (see section 10.4 for more)

Question 47

When can dividends be paid?

Answer 47

When they have been officially declared by the board of directors

Question 48

What is common with a dividend declaration in terms of names of the three pertinent dates?

Answer 48

• the date is shown as the “date of declaration”
• the date they are payable is shown as “date of record”
• the date is also declared that they will be paid (“date of payment”) and they become a liability once declared

Question 49

Journal entry for date of declaration of dividends

Answer 49

Debit cash dividends declared
Credit dividends payable

To record $0.50 per common share cash dividend declared; 3,900 shares x $0.50/share = $1,950

Question 50

What is the alternative way to record the date of declaration of cash dividends?

Answer 50

Debit retained earnings
Credit dividends payable

This is a shortcut to avoid having to do a closing entry for dividends later

Question 51

Date of payment of dividends journal entry

Answer 51

Debit dividends payable (to reverse the entry from the date of record)
Credit cash (to actually pay the people)

to record payment of dividend

Question 52

If cash dividends is declared and that account is used in the longer method, how do you close this?

Answer 52

look at the third main entry to see the closing

If you use the alternative way, you do not need to close

Question 53

cumulative dividends

Answer 53

the accumulation of undeclared dividends from one year to the next

Question 54

cumulative dividends

Answer 54

the accumulation of undeclared dividends from one year to the next

Question 55

cumulative preferred shares

Answer 55

require that any unpaid dividends accumulate from one year to the next and are payable from future earnings when a dividend is eventually declared by a corporation

These accumulated dividends must be paid before any dividends are paid on common shares

Question 56

dividends in arrears

Answer 56

unpaid dividends

they are not recorded as a liability on the balance sheet of the company until they have been declared by the board of directors, however, the disclosure of dividends in arrears must be made in a note to the financial statements

Question 57

non-cumulative preferred share

Answer 57

a dividend not declared by the board of directors in any one year is never paid to shareholders

Question 58

Declaring dividends

Answer 58

Question 59

share dividend

Answer 59

a dividend given to shareholders in the form of shares rather than cash

This allows the declaring corporation to retain cash in the business and reduce the need to finance its activities through borrowing

Like a cash dividend it will reduce retained earnings.

However, a share dividend does not cause assets to change, it just transfers an amount from retained earnings to contributed capital

Question 60

Three dates for share dividends

Answer 60

1. date of declaration
2. date of record
3. date of distribution

there is no date of payment as there was for a cash dividend since they are distributing shares or giving shares, not paying

Question 61

Journal entry for declaring common shared dividends (1st way that will require a closing entry)

Answer 61

Debit share dividends declared
Credit common share dividends distributable

to record declaration of share dividend; 5000 shares x 10% = 500 shares; 500 shares x $4 = $2,000

Question 62

Journal entry for declaring common share dividends (2nd way that does not require a closing entry later)

Answer 62

debit retained earnings
credit common share dividends distributable

Question 63

Journal entry on share dividend distribution date

Answer 63

debit common share dividends distributable
credit common shares

to record distribution of share dividend

this will transfer the money from retained earnings to share capital

Question 64

Does total equity change when there is a share dividend?

Answer 64

No

Question 65

Share dividend: calculating new total share value amount when share dividends are declared at 20 percent increase

Answer 65

total share value = (market price of new)(quantity new shares) + total value of old shares

You can find the quantity of new shares by 1.2 times the old share quantity since they have a 20% share increase.

Question 66

Share dividend: calculating the new retained earnings amount

Answer 66

Question 67

book value of a share

Answer 67

the amount of net assets represented by one share

Question 68

book value of a common share

Answer 68

the amount of net assets not claimed by creditors and preferred shareholders

Question 69

book value of a preferred share

Answer 69

the amount that preferred shareholders would receive if the corporation were liquidated

Question 70

book value per preferred share

Answer 70

(paid-in capital for preferred shares plus dividends in arrears) / number of preferred shares outstanding

Question 71

book value per common share

Answer 71

= (total equity - (paid-in capital for preferred shares + dividends in arrears) ) / number of common shares outstanding

Question 72

book value per common share picture

Answer 72

Question 73

Closing the income summary account

Answer 73

Just use the credit balance that is provided directly in the question to close the income summary account.

If it is not provided you may need to look at past transactions that affected income?

Question 74

Share dividends: answer the question in the picture

Answer 74

Question 75

Share dividends and closing income summary: answer the question in the picture

Answer 75

Question 76

Sample statement of changes in equity

Answer 76

Question 77

Sample statement of changes in equity different

Answer 77

Question 78

Statement of changes in equity when share dividends are used

Answer 78

Main thing to remember is that we do not “issue shares” anymore, rather just show them in the dividends row even though new shares are issued as dividends!

The image shows your errors.

Instead do not include the entire row of “issued shares”, and put the 108,000 under common shares as well as dividends so that the equity of that row becomes zero.

Question 79

Statement of changes in equity correct for share dividends

Answer 79

Question 80

Using the photo, calculate the market value of common shares.

Answer 80

$500,000

Calculated by $10 times the number of common shares currently issued and outstanding which is 50,000 in this example

Question 81

Using the photo, calculate the capital contributed by residual owners

Answer 81

$400,000

Residual owners are people holding shares that are not preferred shareholders.

The capital contributed by them can be found by taking the total contributed capital and subtracting the value of the preferred share capital. But you can also see this value directly by looking at the “common shares issued and outstanding” row value on the right.

So this one is intuitive so long as you know what residual means.

Question 82

Using the photo, calculate book value per common share

Answer 82

$15

This is found by looking at total equity and subtracting what is owed to the preferred shareholders, then dividing by the total number of common shares. In this case there are no dividends in arrears to worry about, so you can subtract $55,000 which is just the value of the preferred shares as printed to the right of the “preferred shares” row.

So ( $805,000 - $55,000 ) / 50,000 = $15

Question 83

Using the photo, calculate book value per preferred share

Answer 83

$11

This is found by taking the paid in capital by shareholders plus dividends in arrears and then dividing by the quantity of issued and outstanding preferred shares.

There are no dividends in arrears in this example, so it is simplified:

$ 55,000 / 5,000 = $11

Question 84

Using the photo, calculate book value per preferred share assuming two years in arrears of dividends

Answer 84

The book value per preferred share should be $19.00

This is found by taking the paid in capital by shareholders plus dividends in arrears and then dividing by the quantity of issued and outstanding preferred shares.

dividends in areas = $4 times 5,000 times 2 years = $40,000

($ 55,000 + $40,000) / 5,000 = $19

Question 85

Using the photo, calculate book value per common share assuming two years in arrears of dividends

Answer 85

The book value per common share should be $14.20

Question 86

Assuming two years of preferred dividends are in arrears, and the board of directors declares dividends of $171,000, calculate the following values:

Using the photo, calculate dividends to common shareholders

Answer 86

The dividends to common shareholders should be $111,000.00

Question 87

Assuming two years of preferred dividends are in arrears, and the board of directors declares dividends of $171,000, calculate the following values:

Using the photo, calculate dividends to preferred shareholders

Answer 87

The dividends to preferred shareholders should be $60,000.00

Question 88

Assuming two years of preferred dividends are in arrears, and the board of directors declares dividends of $171,000, calculate the following values:

Using the photo, calculate dividends per common share

Answer 88

The dividends per common share should be $2.22