PowerPoint to accompany
Companies:
Share capital
and the
balance
sheet
Chapter 14
Learning Objectives
1. Identify the characteristics of a company
2. Record the issue of shares
3. Prepare the shareholders’ equity section
of a company balance sheet
4 Account
4.
A
t for
f cash
h dividends
di id d
5. Use different share values in decisionmaking
6. Evaluate return on assets and return on
shareholders’ equity
7. Account for the income tax of a company
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Objective 1
Identify the characteristics
of a company.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Characteristics
 separate legal entity
 continuous life and transferability of
ownership
 no mutual agency
 limited liability of shareholders
 separation of ownership and
management
 company taxation
 government regulation.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Forming a company
 The process of creating a company
begins when the organisers
(promoters) obtain a certificate of
registration from ASIC.
 The Corporations Act includes a
number of basic rules for managing
companies.
 The company can accept these rules or
replace them with their own company
constitution.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Forming a company
 Shareholders elect the board of
directors.
 The board sets policy, appoints the
officers and elects a chairperson
officers,
chairperson.
 The board also designates the
managing director, who is often known
as the chief executive officer (CEO).
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Forming a company
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Share capital
 Company ownership is evidenced by a
‘share certificate’ or ‘shareholder
holding statement’ which may be for
any number of shares.
 See Exhibits 14-3 and 14-4 pages 536
-37 in your textbook.
 A share that is held by a shareholder is
said to be an ‘issued share’.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Shareholders’ equity
Owners’ equity in the company
has two components:
Share capital
Retained profits
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Shareholders’ equity example
On June 1, the Wong Company
issued shares valued at $10,000.
June 1
Cash
Share Capital
10,000
10,000
Issue of share
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Shareholders’ equity
example
Wong Company
net profit
for the year was $8,000.
June 30
Income Summary
Retained Profits
8,000
8,000
To close net profit to Retained Profits
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Shareholders’ rights
 The ownership of shares entitles
shareholders to four basic rights,
unless specific rights are withheld by
g
agreement.
1 Vote.
2 Dividends.
3 Liquidation.
4 Pre-emption.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Classes of shares
 Ordinary shares are the most basic
form of capital share.
 Preference shares give the owners
certain advantages over ordinary
shareholders (but they may have
limited voting rights).
 In Australia shares are now issued
without a par value (it makes the
accounting easier).
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Objective 2
Record the issue of shares.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Issuing shares example
 On January 13, Blue Mountains Limited
(which manufactures skateboards)
issues 10,000 ordinary shares for $10
per share.
p
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Issuing shares example
The 10,000 shares were issued for $10 each.
January 13
Cash
Ordinary Share Capital
100,000
100,000
Issue no par value ordinary share
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Issuing shares example
 On February 11, Eyles Company
issued 15,000 shares of its ordinary
share for a building worth $100,000.
 What is the journal entry?
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Issuing shares example
February 11
Building
100,000
Ordinary Share Capital (15,000 shares)
100 000
100,000
Issued ordinary share in exchange for a building
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Issuing shares example by
instalment
 Shares may sometimes be issued by
instalments.
 Money may be payable:
 When the investor makes application for
the shares
 When the shares are issued or the
allotment made
 Later when more money is asked for or a
call is made.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Issuing shares example
by installment
 Huang Limited issues 10,000 shares:
 $5 payable on application
 $3 on allotment and
 $2 call
call.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Issuing shares example
Applications received for 10,000 shares.
Cash Trust (10,000 x $5)
Application
50,000
50,000
Received application money, to be held in trust
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Issuing shares example
The 10,000 shares were issued (allotted).
Application (10,000 x $5)
Allotment (10,000 x $3)
Ordinary Share Capital
50,000
30,000
80,000
Issue ordinary share
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Issuing shares example
The application money is now the
company’s (ours) so it can be transferred
from the trust account to our cash account.
Cash
Cash Trust
50,000
50,000
Transfer application money to company’s
bank account
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Issuing shares example
Received allotment money.
Cash
Allotment
30,000
30,000
Collected amount due on allotment ($3 x 10,000)
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Issuing shares example
Made the call and then received the money.
Call
20,000
,
Ordinary Share Capital
20,000
Called up balance outstanding on partly paid shares
Cash
20,000
Call
20,000
Collected call on ordinary shares
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Issuing shares example:
Oversubscription
 Investors may apply for more shares
than are available to be issued.
 If there is an oversubscription
management may:
 Refund the money or
 Apply it to later amounts payable;
allotment and or call.
 Assume Huang received applications
for 12,000 shares (12,000 x $5 =
$60,000).
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Issuing shares example
Application
Cash Trust
10,000
10,000
Refund excess application money
Or
Application
Allotment
10,000
10,000
Apply excess application money to amount
due on allotment
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Issuing shares example:
Forfeiture
 Investors who do not pay the allotment
or call may forfeit their shares.
 Assume the holder of 100 Huang
shares did not pay the call
call.
 The “Call” account was originally
debited $20,000.
 But only $19,800 cash was received.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Issuing shares example
To forfeit the shares.
Ordinary Share Capital (100 x $10) 300
Call (100 x $2)
300
Forfeited Share Account
700
Record forfeiture of 100 shares
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Issuing shares example
The forfeited shares were reissued
for $9.50 each.
Cash
Forfeited Share Account
Ordinary Share Capital
950
50
1,000
Reissued 100 forfeited shares
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Issuing preference shares
 Accounting for preference shares
follows the pattern illustrated for
ordinary shares.
Shareholders’ equity on the balance
 Shareholders
sheet lists, ordinary shares, preference
shares, and retained profits – in that
order.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Objective 3
Prepare the shareholders’
equity section of a company
balance sheet.
sheet
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Review of Accounting
for Paid-up Capital
Shareholders’ Equity
Contributed equity:
y
400 ordinary shares, fully paid
100 preference shares (70c per share
annual dividend) fully paid
Retained profits
Total equity
4,000
2,000
3,000
9,000
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Review of accounting
for share capital
 Contributed equity and retained profits
represent the shareholders’ equity
(ownership) in the assets of the
company.
 Contributed equity comes from the
company’s shareholders who invested
in the company.
 Retained profits come from the
company’s customers (revenue –
expenses) – but become the
shareholders’.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Objective 4
Account for cash
dividends.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Dividend dates
 A company must declare a dividend
before paying it.
 The board of directors alone has the
authority to declare a dividend
dividend.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Dividend dates
Three relevant dates for dividends are:
 Declaration date
 Date of record
 Payment date
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Cash dividends example
 On April 1, the board declares a
dividend of $1 per share payable June
15 to shareholders of record on May
15.
 There are 60,000 shares outstanding.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Cash dividends example
April 1
Retained Profits
60,000
Dividends Payable
Declared a cash dividend
60,000
June 15
Dividends Payable
Cash
Paid a cash dividend
60,000
60,000
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Cash dividends example
$50,000 dividends declared
1 000 Preference shares
1,000
$6 annual dividend per share
25,000 Ordinary shares
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Cash dividends example
Preference dividend
$6 × 1,000 = $6,000
Ordinary dividend
$50,000 – $6,000 = $44,000
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Cash dividends example
Suppose there were 10,000 preference
shares, $6 annual dividend per share
Preference dividend
$6 × 10,000 = $60,000
(The full $50,000 goes to preference shares)
Ordinary shareholders receive nothing
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Cumulative and non-cumulative
preference shares
 If the preference is cumulative, the
$10,000 shortage must be paid before
any dividend is paid to ordinary
shareholders in the future.
 If non-cumulative, a passed dividend
not paid, or not fully paid, is simply lost.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Objective 5
Use different share values
in decision-making.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Share values
 The business community refers to
different share values in addition to
the original issue price:
 market value (on the evening
news).
 book value.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Share values example
Book value per share =
Total shareholders’ equity ÷ Total shares outstanding
Book value p
preference =
(Liquidation value + Dividends in arrears)
÷ Number of shares outstanding
Book value ordinary =
(Shareholders’ equity – Amount allocated to preference)
÷ Number of shares outstanding
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Share values example
Shareholders’ Equity
Contributed Equity:
Ordinary share, 10,000 shares, fully paid $300,000
Retained profits
Total shareholders’ equity
100,000
$400,000
Book value per share: $400,000 ÷ 10,000 = $40
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Share values example
Book value per share preference:
($210,000 + $12,000) ÷ 2,000 = $111.00
liquidation + cumulative ÷ number = book
value
dividends shares value
Book value per share ordinary:
($606,000 – 222,000) ÷ 10,000 = $38.40
(total equity – preference ÷ number = book
book value) shares
value
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Objective 6
Evaluate return
on assets and return on
shareholders’ equity.
shareholders
equity
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Return on assets
It is a measure of a company’s ability to
generate profits from the use of its
assets
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Return on equity
It is a measure of the profits earned
from the ordinary shareholders’
investment in the company
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Objective 7
Account for the income tax
of a company.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Accounting for income taxes
by companies
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Accounting for income taxes
by companies
 Deferred income tax liability is the
difference between income tax expense
and income tax payable for any one year:
 When the expense > the payable
 Future
F t
tax
t benefit
b
fit arises
i
when
h expense <
payable.
 Revenues and expenses may be reported
in different periods for income statements
and tax return purposes.
 Alternative depreciation methods may be
used.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Ethical issues
 Issuing shares for cash poses no
ethical challenge as the value of the
asset received is clear
 Issuing shares for other assets can
pose a challenge due to the difficulty in
valuing assets, different valuers may
value the asset differently
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
PowerPoint to accompany
End of
Chapter 14
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia