Chapter 12 (Week 6)

Question 1

Corporation

Answer 1

Entity separate and distinct from its owners

Publicly held: may have thousands of shareholders

Privately held: usually has only a few shareholders and doesn’t offer its shares for sale to the general public

Purpose: corporation may be organised for the purpose of making a profit, or it may be not for profit

Question 1

Forming a corporation

Answer 1

File an application with the appropriate government agency in the jurisdiction
Charter provided by government
By laws are established - internal rules and procedures for conducting the affairs of the corporation
- A license might also be needed

Question 2

Organisation costs

Answer 2

costs incurred in the formation of a corporation

Question 3

Shareholder rights

Answer 3

1. Vote in election of board of directions at annual meeting
2. Share the corporate earnings through receipt of dividends
3. Keep the same percentage ownership when new shares are issued (preemptive right)
4. Share in assets upon liquidation in proportion to their holdings –> residual claim

Question 4

Authorised shares

Answer 4

charter indicates how many can be sold

Question 5

Issuance of shares

Answer 5

Issue shares directly to investors, or indirectly through an investment banking
Indirect: the investment banker buys the shares from the corporation at a stipulated price and resells them to investors

Question 6

Par and no par values

Answer 6

Par (nominal): ordinary shares to which the charter has assigned a value per share
No par: ordinary shares to which the carted hasn’t assigned a value per share

Question 7

Share capital

Answer 7

total amount of cash and other assets paid in to the corporation by shareholders in exchange for shares

Question 8

Retained earnings

Answer 8

net income that a corporation retains for future use

Question 9

Issuing par value ordinary shares for cash

Answer 9

Ordinary for par: credit Share capital ordinary

Ordinary for more than par: credit Share premium ordinary

Ordinary for less than par: debit Share premium ordinary (if credit balance) or debit Retained earnings (if no credit balance)

Question 10

Issuing no par ordinary shares for cash

Answer 10

Credits Share capital ordinary

Ordinary for more than no par: credit to Share premium ordinary

Question 11

Preference shares

Answer 11

contractual provisions that give them some preference or priority over ordinary shares.

Question 12

Treasury shares

Answer 12

a corporation’s own shares that it has issued and subsequently reacquired from shareholders but not retired

They might be acquired to:
- reissue the shares to employees under compensation
- have additional shares available
- reduce the number of shares outstanding

Question 13

Purchase of treasury shares

Answer 13

Use the cost method:

Debit Treasury Shares for the price paid to reacquire the shares

When the company disposes of the shares - credits to the Treasury Shares the same amount it paid to reacquire the shares

Question 14

Outstanding shares

Answer 14

number of issued shares that are being held by shareholders

Question 15

Dividend

Answer 15

A corporation’s distribution of cash or shares to its shareholders on a proportional to ownership basis

Question 16

Cash dividend

Answer 16

Proportional to ownership basis distribution of cash to shareholders

Question 17

Entries for cash dividends

Answer 17

On the declaration date, the board of directors authorises the cash dividend and announces it to shareholders
Debit cash dividends - decrease retained earnings

At the record date, the company determines ownership of the outstanding shares for dividend purposes
No entry

At the payment date, the company makes cash dividend payments to the shareholders of record and records the payment of the dividend
This payment reduces both current assets and liabilities

Question 18

Cumulative dividends

Answer 18

Stipulates that preference shareholders must be paid both current year dividends and any unpaid prior year dividends before ordinary shareholders are paid dividends

Question 19

Share dividend

Answer 19

Proportional to ownership distribution to shareholders of the corporation’s own shares

Small share dividend: less than 20 - 25% of the issued shares - fair value (market price) per share
Large share dividend: more than 20 - 25% of the issued shares - the par or stated value

Question 20

Share split

Answer 20

Involves issuance of additional shares to shareholders according to their percentage ownership

Results in the reduction in the par or stated value per share

Question 21

Return on ordinary shareholders’ equity formula

Answer 21

(Net income - Preference dividends) / Average ordinary shareholders’ equity