chapter 11 Flashcards
what is a corporation
is a separate legal entity, it is distinct from its owners (shareholders) and has rights and privileges of a legal person
what is a public corporation
: A public corporation is one where anyone can buy shares on the open market.
A public corporation will normally have many shareholders (could be thousands)
A public corporation will have to use IFRS
what is a private corporation
A private corporation is one where the shares will not be traded on the open market.
Normally only has a few close shareholders
A private corporation has the option to use either IFRS or ASPE
what are the advantages of a corporation
- limited liability of shareholders: shareholders cannot lose more money than they have invested in the corporation.
- continuous life: the corporation will continue to exist even upon shareholders death.
- Income tax: a corporation will pay corporate income tax as a separate entity. There is typically a lower tax rate compared to individual tax rate.
can transfer rights of ownership
ability to acquire capital (cash) by issuing shares
separation of management and onwership
transferable ownership rights
it is generally easy to transfer the ownership rights (shares).
Transactions between two independent investors do not affect the corporation’s accounting records.
Shares (stocks) are actively traded in the market so are easy to acquire
corporation management
The owners (shareholders) do not have to manage the firm directly. They will appoint a Board of Directors who then hires CEO and Executives.
what are disadvantages of a corporation
corporations, especially public ones, must follow certain government regulations.
More monitoring by security commissions
Financial reporting and disclosure requirements
Generally, this will result in increased costs
what are the rights of shareholders
vote to elect the board of directors
share the corporate earnings through dividends
share in assets upon liquidation in proprtion to their holdings (residual claim)
what is share capital
After a corporation is incorporated, the ownership will be sold in the form of shares, which can have different characteristics and will be referred to as the share capital
what are authorized shares
are the maximum number of shares of capital stock that can be sold to the public. could be unlimited or specified
does the authorization of share capital result in a journal entry
no, only if you sell a share
what is initial public offering (IPO)
the initial offering of a corporations shares to the public
what are issued shares
are authorized shares of stock that have been sold. These include both outstanding shares (owned by investors) and treasury shares (repurchased by the company).
what are unissued shares
are authorized shares of stock that never have been sold
The number of authorized shares
limited or unlimited (mostly unlimited) and authorized shares are not recorded, disclosed only.
how are shares issued
The first stock issuance normally through initial public offering (IPO)
Share price is set by the company
Second time and on – referred to as a Seasoned equity offering (SEO)
what is FMV
Once issued, shares of publicly held companies trade on organized exchanges at the fair value (FMV) – share price is determined by market forces.
what is market capitalization
: a measure of the FMV of the corporation’s total equity. Calculated by multiplying the total shares outstanding to the FMV on a given date.
what are common shares
all corporations have common shares. These are the shares that will normally control the corporation as they have voting rights. When you own common shares of a company, you become a shareholder and have a claim on its assets and earnings
how do you issue for common shares
debit cash
credit common shares
When a public company’s shares are issued for a noncash consideration
they should be recorded at the fair value of the consideration received (record at the value of the object you are getting)
what are preferred shares
: these are optional and will have some special (optional) features
what are the features of preferred shares
Dividend preference and liquidation preference
Other preference: convertible to common shares, retractable (shareholder option), redeemable (company option)
Normally do not have voting rights
Price will normally be less volatile
how are preferred shares normally issued
will normally be issued with a specified dividend rate
what is a dividend preference
preferred shareholders must be paid dividends before any are paid to the common shareholders
what are the two types of dividends preference
Cumulative: when dividends are declared, preferred shareholders must be paid both current year dividends and any unpaid prior year dividends.
Noncumulative: if dividends are not declared in a year, these are lost forever.
what are dividends in arrears
Dividends that were not declared on cumulative preferred shares during a period. NOT A LIABILITY
what are redeemable preferred shares
where the issuing corporation has the option to buy back the shares from shareholders at specific future dates and prices. This feature gives the corporation flexibility because it allows them to eliminate these shares when it’s financially beneficial. In Canada, most preferred shares come with this redeemable feature, providing companies with a tool to manage their capital structure effectively.
what are retractable preferred shares
The shareholder has the right to require the company to repurchase shares at specified future dates and prices
similarities between common shares and preferred shares
Both are equity instruments on which dividends may be declared and paid.There is no legal requirement for a company’s board of directors to declare dividends on either type of share.
differences between common shares and preferred shares
Preferred shareholders do not have the right to vote at annual general meetings.
Preferred shares have preferences over common shareholders with regard to dividend payments.
Preferred shareholders have a priority claim over the company’s assets upon liquidation.
While both types of shares have the potential for price appreciation, the prices for preferred shares tend to be less volatile than for common shares because any income not distributed through dividends accrues to the common shareholders, as do any losses
how are the shares issued
, for cash or noncash consideration
why does a company repurchase shares
Increase trading price on securities markets
Reduce number of shares issued (increases earnings per share and return on common shareholders’ equity)
Buyout hostile shareholders
Have shares available for CEO compensation or other uses
When you are recording the entry for the repurchase of shares or the retirement, what are the steps
Removing the cost of the shares from the share capital account
Based on the average share price (calculated right before the repurchase by dividing the share capital account by the total number of related shares)
Recording cash paid – credit to cash account
Recording a gain or loss on the reacquisition
Will not be reported on the income statement
Will impact the contributed surplus or retained earnings account, depending on if it is a gain or loss
If the shares are repurchased for an amount below their average cost
they have essentially been repurchased for a “gain” . debit to common shares, credit cash, credit contributed surplus
what is contributed surplus
A source of contributed capital that can result from certain types of equity transactions, including the reacquisition of shares
contributed surplus formula
average cost- cash paid
If the shares are repurchased for an amount above their average cost,
they have essentially been repurchased for a “loss” . debit common shares, de bit contributed surplus, debit retained earnings, credit cash
what is a dividend
is a pro-rata distribution of a portion of the corporation’s retained earnings to shareholders
does a company have ti pay dividends
no
For a corporation to declare and pay a cash dividend, it must meet a two-part solvency test under the Canada Business Corporations Act
The company must have sufficient cash or resources to be able to pay their liabilities as they become due after the dividend is declared and paid.
The net realizable value of the assets must exceed total of liabilities and share capital.
have to argue that the company will be in a good financial position after they pay dividends
what is a cash dividend
most common form of dividends. a cash dividend decreases assets (through the Cash account) and shareholders’ equity (through the Retained Earnings account)
who can a cash dividend be paid to
preferred or common shareholders
formula for retained earnings at thee nd of the period
re at beginning+ net income- dividends declared
what is a stock dividend
when a corporation distributes some of their own shares to shareholders instead of cash.
what is a stock split
technically not a dividend but is like a stock dividend in the sense that additional shares are issued to existing shareholders.
what Is a stock splits main purpose
to increase the marketability of the shares by lowering the share price.
what is the declaration date
the date the company directors decide to issue a dividend. This is the date a legal obligation is created.
what is the record date
the date the ownership of shares is determined. That means that whoever owns the shares on that date will be entitled to receive the dividend paymen
what is the payment date aka distribution date
the date the payment is made to shareholders.
what is a stock dividend
a distribution of the corporation’s own shares instead of cash to the shareholders. a percentage and the company gets the percentage more. a stock dividend does not change assets, liabilities, or total shareholders’ equity.
A company may distribute a stock dividend for the following reasons:
Satisfy shareholders’ dividend expectations without paying cash.
Increase marketability of shares (a higher number of shares will decrease the share price on the market, which makes the shares more affordable).
To show that a portion of shareholders’ equity has been reinvested in the legal capital of the business (so is unavailable for future cash dividends).
what are the main components of equity
contributed capital and retained earnings
what does contributed capital include
Share capital: preferred and common shares
Contributed Surplus: amounts contributed from acquiring and retiring shares
Accumulated other comprehensive income (AOCI
This type of equity only exists under IFRS.
The year end balance formula
beginning AOCI +/- other comprehensive income (loss) = ending AOCI.
what is the payout ratio
The payout ratio measures the percentage of profit distributed in the form of cash dividends to common shareholders
what is the formula for payout ratio
cash dividends declared ➗ net income.
To determine if a higher than average ratio is good or bad
, it depends on a combination of investors strategy/company policy:
what is higher than average
investors that value dividend income over growth in share price will prefer this company.
what is lower than average
investors that value growth in share price over dividend income will prefer this company.
what is the dividend yield
yield is a measure of the shareholders return on their investment
what is the dividend yield formula
Dividends declared per share ➗ Market price per share
how do you know if a higher or lower ratio is better for dividend yield
depends on investors
what is the basic earnings per share
income earned on a per share basis.
how to calucate basic earnings per share
Net income available to common shareholders ➗ Weighted average number of common shares
is it better to have a higher basic earnings per share
yes
when is basic earnings per share not useful
is not a useful comparison between companies as all companies will have a different number of shares outstanding.
(comparing different companies )
what is return on equity
Measures the company’s profitability from the shareholders’ viewpoint
what is the formula for return on equity
Net income available to common shareholders ➗ Average common shareholder’s equity. can compare with other companies
is it better to have a higher return on equity?
yes
advantages of debt financing
The ownership of current shareholders remains the same and are not decreased or diluted by new equity from new shareholders.
Interest is a deductible expense for tax purposes and dividends are not.
advantages of equity financing
Dividends are discretionary and not legally binding if not declared vs interest payments that are legally binding.
Funds received from shareholders do not have to be returned to shareholders unless company is liquidated. Loan must be repaid to creditors.
