Equity Flashcards
A company selling shares is … required to repay the capital to its public investors
never
Shares represent residual corporate interest that …
- … bears the risks of the losses
- … receives the benefits of success
- … no guaranteed dividends or assets upon dissolution.
Ordinary shares
Represent the basic ownership interest.
- To share proportionately in profits and losses
- To share proportionately in management (right to vote).
- To share proportionately in new issues of shares (preemptive right).
Preference shares
Sacrifice certain basic rights in return for other special rights:
- Preferred dividends (cumulative and non-cumulative)
- No voting rights (not always)
- Alternatively: more rights per share
- Convertible in ordinary shares
- Callable firm
Equity
Residual interest in the firm’s assets after deducting all liabilities.
Two primary sources of equity
- Contributed capital (Ordinary/Preference shares: share premium)
- Retained earnings
Two types of issuance:
- at “par value” : company maintains two accounts separately for preference and ordinary shares.
- at “non-par value” : just the account (share capital)
Costs of issuing shares:
- Direct costs: underwriting costs, accounting/legal fees
- Reduction of the amount paid-in -> debit to share Premium (no recording of expense)
Lump-sum sales
- Issuing two or more classes of securities for a single payment.
2 ways to account for lump-sum
- Proportional: allocate lump sum on a proportional basis of fair values.
- Incremental method: allocate first securities with known fair value, rest to the class without fair value.
Shares issued in non-cash transactions
- ## shares issued in exchange for services or property other than cash.
What are the benefits/incentives for coporations to purchase their outstanding shares back?
- To provide tax-efficient distributions of excess cash to shareholders.
- To increase earnings per share and return on equity.
- To provide shares for employee compensation contracts or to meet potential merger needs.
- To better fight hostile takeover attempts or to reduce the number of shareholders.
- To make a market in the shares.
What happens after re-acquiring?
either:
- Shares are retired, OR
- Shares are held in “treasury” account -> treasury shares
Facts on treasury shares
Treasury shares are not an asset!
- Reduction in assets and equitity
- No voting rights
- Basically the same as unissued ordinary shares.
Treasury shares may be re-issued.
Treasury shares: cost method
idea: account for the cost of buying back the shares.
Debit : “treasury shares (bs) account
Credit : “Cash (bs) account
Report “treasury shares” account as a deduction from equity on the balance sheet. (contra-equity account).
What happens when a company sells treasury shares?
3 scenarios :
- At cost:
debit “cash” + credit “treasury shares”
- Above cost:
debit “cash” + credit “treasury shares & Share premium-treasur “ - Below cost:
debit “cash & share-premium-treasury”
credit “treasury shares”
Important!!!! Below cost is only possible if there is enough credit in the “Share Premium-Treasury” . Otherwise: debit any additional excess of cost over selling price to the “Retained earnings”.
What does retiring shares mean?
Decision results in :
- cancellation of the treasury shares and
- a reduction in the number of shares of issued shares.
What does cancelation mean?
What does cancelation mean?
- Retired treasury shares have the status of authorized and unissued shares
- Company does not need approval from its shareholders to issue new shares and capital based on retired treasury shares.
Give 4 types of dividends
- Cash dividends
- property dividends
- liquidating dividends
- Share dividends
Few companies pay dividends in amounts equal to their legally available retained earnings. WHY?
- Maintain agreements with creditors (debt covenants)
- To finance growth or expansion
- To smooth out dividend payments
- To build up a cushion against possible losses
Cash dividends: what are the 3 steps
- declare
- record (do nothing)
- payment
Cash dividends : date of declaration
debit retained earnings
credit dividend payable
Cash dividends : date of payment
debit dividends payable
credit cash
Property dividends : date of declaration
debit :
- equity investment
- retained earnings
credit:
- unrealized holdings gain/loss - income
- property dividends payable
Property dividends: date of payment
debit:
- property dividends payable
credit:
-equity investments
What is the key difference between liquidating dividends and cash/property dividends?
- Liquidating dividends not based on retained earnings.
- Instead, they reduce share premium/share capital accounts.
Liquidating dividends : date of declaration
debit:
- retained earnings (0.5x)
- share premium (0.5x)
credit:
- dividends paybale x
Liquidating dividends : date of payment
debit:
- dividends payable
credit:
- cash
Share dividends : declaration date
debit:
- retained earnings
credit
-share dividend distributable (EQ)
Share dividends : date of payment
debit
- share dividend distributable
credit:
- share capital
What happens with a share splits
- Firm does not distribute earnings via dividends -> retaining earnings increases -> share price increases.
- consequence: shares are less accessible to investors due to high share price.
- no journal entry needed.
Formula lump-sum
factor = FV * nbr of shares / total lumpsum
Record the adjustment of the carrying value of the portfolio.
debit:
- investment - trading securities
Credit:
- unrealized gain (loss) income.
