Chapter 10 Terms Flashcards
Privately-held shares
A privately-held corporation’s shares are not issued for sale to the general public.
Shares give partial ownership of a company.
Publicly-held shares
Issued for sale to the general public. Sometimes held on a stock market like the Toronto Stock Exchange or the new York Stock Exchange.
How is a corporation different from an individual?
- 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.
Classes of shares
The types of shares that the company is allowed to offer as decided in the legal documents when the company was created.
Authorized shares
The quantity of shares that are allowed as stated in the legal documentation when the company is created.
Certificate of Incorporation
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.
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.
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.
General regulations for incorporated companies
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.
How do you know a company has limited liability?
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.
The rights and privileges usually attached to common shares
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
pre-emptive right
right to maintain their proportionate interests in the corporation if additional shares are issued.
Can shareholders back out of a company?
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.
Preferred shares
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
Status of shares
EPS
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.
Debt financing advantages
Advantage 1: Earnings per share
Advantage 2: Control of the corporation
Advantage 3: Income taxes expense
Debt financing Advantage 1: Earnings per share
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.
Debt financing Advantage 2: Control of the corporation
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.
Debt financing Advantage 3: Income taxes expense
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.
Disadvantages of debt financing
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.
Practice 10.1 page 8 activity
You couldn’t get the values to work in the first row but now you know how
stated value of a share
the amount for which it is issued
Also called nominal value
other name for stated value (shares)
nominal value
other name for stated value (shares)
nominal value
share par-value
the amount stated in the corporate charter below which shares cannot be sold upon initial offering
In this course are we using stated value or par-value?
stated value will be assumed for all shares in this course
Journal Entries to issue common shares
debit cash
credit common shares
to record the issuance of 1,000 common shares at $10 per share
Journal Entries to issue common shares
debit cash
credit common shares
to record the issuance of 1,000 common shares at $10 per share
Journal entries to issue preferred shares to the owner of land and buildings
debit land
debit building
credit preferred shares
To record the issuance of 2,500 preferred shares in exchange for land and buildings
Journal entries to issue preferred shares to the owner of land and buildings
debit land
debit building
credit preferred shares
To record the issuance of 2,500 preferred shares in exchange for land and buildings
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?
organization costs (start-up costs)
In journal entries it will be called organization expense
What is the journal entry to compensate organizers of a company for their services by issuing common shares?
debit organization expense
credit common shares
to record the issuance of 500 common shares in exchange for organization efforts
Headings for equity section of the balance sheet including preferred and common shares
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)
Journal entry to repurchase common shares
debit common shares
credit cash
to record the repurchase of 200 common shares at $10 per share to be held in treasury
Journal entry to record the repurchase of common shares at $9 per share instead of the issue price of $10 per share
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
Journal entry to record the repuchase of common shares at $9 per share instead of the issue price of $10 per share
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
Equity section of the balance sheet including contributed surplus
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)
Journal entry for repurchasing and cancelling common shares for $11 per share when the average issue price was $10 per share
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
What is a share split
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.
Can dividends come from share capital?
No
Where do dividends come from?
retained earnings
What are considerations when choosing to declare dividends? What do the board of directors look out for?
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
Consideration 1 when declaring dividends: lack of cash
- this happens since owners try to use the cash quickly to buy assets that will help them to make more profits
Consideration 2: a policy of the corporation may preclude (prevent the occurance of) dividend payments
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
Consideration 3: no legal requirement that dividends have to be paid
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
Consideration 4: dividends may be issued in shares of the corporation rather than in cash
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)
When can dividends be paid?
When they have been officially declared by the board of directors
What is common with a dividend declaration in terms of names of the three pertinent dates?
- 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
Journal entry for date of declaration of dividends
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
What is the alternative way to record the date of declaration of cash dividends?
Debit retained earnings
Credit dividends payable
This is a shortcut to avoid having to do a closing entry for dividends later
Date of payment of dividends journal entry
Debit dividends payable (to reverse the entry from the date of record)
Credit cash (to actually pay the people)
to record payment of dividend
If cash dividends is declared and that account is used in the longer method, how do you close this?
look at the third main entry to see the closing
If you use the alternative way, you do not need to close
cumulative dividends
the accumulation of undeclared dividends from one year to the next
cumulative dividends
the accumulation of undeclared dividends from one year to the next
cumulative preferred shares
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
dividends in arrears
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
non-cumulative preferred share
a dividend not declared by the board of directors in any one year is never paid to shareholders
Declaring dividends
share dividend
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
Three dates for share dividends
- date of declaration
- date of record
- 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
Journal entry for declaring common shared dividends (1st way that will require a closing entry)
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
Journal entry for declaring common share dividends (2nd way that does not require a closing entry later)
debit retained earnings
credit common share dividends distributable
Journal entry on share dividend distribution date
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
Does total equity change when there is a share dividend?
No
Share dividend: calculating new total share value amount when share dividends are declared at 20 percent increase
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.
Share dividend: calculating the new retained earnings amount
book value of a share
the amount of net assets represented by one share
book value of a common share
the amount of net assets not claimed by creditors and preferred shareholders
book value of a preferred share
the amount that preferred shareholders would receive if the corporation were liquidated
book value per preferred share
(paid-in capital for preferred shares plus dividends in arrears) / number of preferred shares outstanding
book value per common share
= (total equity - (paid-in capital for preferred shares + dividends in arrears) ) / number of common shares outstanding
book value per common share picture
Closing the income summary account
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?
Share dividends: answer the question in the picture
Share dividends and closing income summary: answer the question in the picture
Sample statement of changes in equity
Sample statement of changes in equity different
Statement of changes in equity when share dividends are used
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.
Statement of changes in equity correct for share dividends
Using the photo, calculate the market value of common shares.
$500,000
Calculated by $10 times the number of common shares currently issued and outstanding which is 50,000 in this example
Using the photo, calculate the capital contributed by residual owners
$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.
Using the photo, calculate book value per common share
$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
Using the photo, calculate book value per preferred share
$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
Using the photo, calculate book value per preferred share assuming two years in arrears of dividends
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
Using the photo, calculate book value per common share assuming two years in arrears of dividends
The book value per common share should be $14.20
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
The dividends to common shareholders should be $111,000.00
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
The dividends to preferred shareholders should be $60,000.00
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
The dividends per common share should be $2.22
