Accounting
Principles
CHAPTER
14
Second Canadian Edition
Weygandt · Kieso · Kimmel · Trenholm
Prepared by:
CORPORATIONS:
ORGANIZATION AND SHARE
CAPITAL TRANSACTIONS
CORPORATE FORM OF
ORGANIZATION
CLASSIFICATION OF
CORPORATIONS
Carole Bowman, Sheridan College

A corporation is a legal entity created by
law that is separate and distinct from its
owners
A corporation’s purpose may be to earn a
profit, or it may be organized as non-profit.
 Classification by ownership distinguishes
between publicly-held corporations (shares
are traded in the stock market) and
privately-held corporations (shares are not
available on the stock market; thus, they are
traded privately).

ILLUSTRATION 14
14--1
CHARACTERISTICS
ADVANTAGES AND DISADVANTAGES
OF A CORPORATION
Advantages








Separate legal existence (A corporation is an
entity in the eyes of the law!)
Limited liability of shareholders
T
Transferable
f bl ownership
hi rights
i h
Ability to acquire capital for corporation
Continuous life of corporation
Corporation management
Numerous government regulations
Additional taxes (entity tax)
•Corporate management professional managers
•Separate legal existence
•Limited liability of
shareholders
•Deferred or reduced income
taxes (ex. manufacturing
deduction, small business
deduction)
•Transferable ownership rights
•Ability to acquire capital
•Continuous life
Disadvantages
•Corporation management ownership separated from
management
•Increased costs and complexity
to adhere to government
regulation
•Potential for additional income
taxes through entity tax.
(Corporation is taxed on income
as an entity, then shareholders are
taxed on dividends as separate
entities!)
Page 1
SHAREHOLDER RIGHTS
ORGANIZATION COSTS



Costs incurred in forming a corporation are
called organization costs.
These costs include fees to underwriters,
legal fees, incorporation fees, and
promotional
ti
l expenditures.
dit
Organization costs are normally expensed in
the year the organization cost is incurred.
To raise capital, the corporation sells shares.
 If only one class of shares exist they are common
shares.
 Ownership rights specified in articles of
incorporation or by-laws.
by-laws
 Legal Capital: Capital that by law or resolution
must remain within a firm and that is restricted
for purposes of dividends or other distributions.
Legal capital is generally equal to the par or
stated value of all outstanding stock. Also called
stated capital. (To violate this rule is essentially a Ponzi scheme.)

Ponzi Scheme
SHARE TERMINOLOGY
A Ponzi scheme is a fraudulent investment operation that pays returns to
separate investors from their own money or money paid by subsequent
investors, rather than from any actual profit earned.
The Ponzi scheme usually entices new investors by offering returns
other investments cannot guarantee, in the form of short-term returns
that are either abnormally high or unusually consistent. The perpetuation
of the returns that a Ponzi scheme advertises and pays requires an everincreasing flow of money from investors to keep the scheme going.
Authorized shares – maximum amount
of shares a corporation is allowed to sell
as authorized by
y corporate
p
charter
 Issued shares – number of shares sold

The scheme is named after Charles Ponzi, who became
notorious for using the technique in early 1920. He had
emigrated from Italy to the United States in 1903. Ponzi
did not invent the scheme, but his operation took in so
much money that it was the first to become known
throughout the United States.
SHARE ISSUE CONSIDERATION
How many shares should be authorized for
sale?
 How should the shares be issued?
 At what price should the shares be issued?
 What value should be assigned to the
shares?

STOCK MARKET PRICE

Shares of publicly held companies are
traded on organized exchanges at dollar
prices per share established by the
interaction between buyers and sellers.
Page 2
PAR VALUE SHARES





Par Value: Shares that have a specific value
assigned in the corporate charter.
Par value is the legal capital per share that must be
kept in the business for protection of corporate
creditors.
This amount cannot be withdrawn by shareholder.
Par value has no relationship to market value.
Seldom used because:
– if market prices rise significantly above par, the low par
value offers little protection to creditors; and
– if market prices fall significantly below par, the
corporation can’t raise capital through sale of shares
NO PAR VALUE SHARES



No Par Value: Shares that have no specific value
assigned in the corporate charter.
Legal capital equals issue price (proceeds).
Most popular form of shares today (more than 90%
of shares in Canadian public companies).
ISSUING PAR VALUE
COMMON SHARES FOR CASH
When common shares have a par value, the par value is credited to the
“Common Shares” equity account.
When the selling price exceeds the par value, the excess is credited to the
“Contributed Capital in Excess of Par Value” (aka “Paid-in Capital”) equity
account. Even though this is capital that is contributed by shareholders, it
may be
be, (depending on provincial or state laws) fully or partially,
partially available for
paying dividend.
Account Titles and Explanation
Stated Value No Par Value Shares:
 Stated Value: The Board of Directors can assign a value to
“no par value” shares.
 This “stated” value becomes the legal capital per share.
 (State law in the US generally prohibits a corporation from
paying dividends or repurchasing shares when doing so
would impair its legal capital. Thus, stated value does offer
stockholders a measure of protection against loss of value.)
 No relationship to market value.
 Not highly popular in Canada.
Credit
5,000
1,000
4,000
ISSUING NO PAR VALUE
COMMON SHARES FOR CASH
Shares are most commonly issued for cash.
When no par value common shares are issued, the
entire proceeds from the issue becomes legal
capital.
Account Titles and Explanation
Cash
Common Shares
To record issue of 1,000 shares at $1/share.
NO PAR VALUE SHARES
with
Stated Value
Debit
Cash
Common Shares
Contributed Capital in Excess of Par Value
To record issue of 1,000 shares with $1.00 par value for
$5.00 a share.
Debit
Credit
1,000
1,000
ISSUING STATED VALUE
COMMON SHARES FOR CASH
When common shares have a stated value, the stated
value is credited to the “Common Shares” equity
account.
gp
price exceeds the stated value,, the
When the selling
excess is credited to the “Contributed Capital in Excess
of Stated Value” equity account.
Account Titles and Explanation
Cash
Common Shares
Contributed Capital in Excess of Stated Value
To record issue of 1,000 shares with $1.00 stated value
for $5.00 a share.
Debit
Credit
5,000
1,000
4,000
Page 3
CORPORATE CAPITAL
In Summary…

ILLUSTRATION 14
14--5
RELATIONSHIP OF PAR, NO PAR AND STATED VALUE SHARES TO
LEGAL CAPITAL

Shareholders’ equity (owner’s equity)
The shareholders’ equity section of a
corporation’ss balance sheet consists of:
corporation
– Contributed capital
Shares
Legal Capital per Share
Par value
No par value
Par value
Entire proceeds
Stated value
Stated value
• Share capital
• Additional contributed capital
– Retained earnings
SHAREHOLDERS’ EQUITY CONTRIBUTED CAPITAL IN EXCESS
OF STATED VALUE
ILLUSTRATION 14
14--6
SHAREHOLDERS’ EQUITY SECTION
Shareholders’ equity
Contributed capital
Common shares, 100,000 no par value
shares authorized, 50,000 issued
Retained earnings
Total shareholders’ equity
130,000
$930,000
ISSUING COMMON SHARES FOR
SERVICES OR NON
NON--CASH ASSETS


Shareholders’ equity
Contributed capital
Common shares, 10,000 shares of $1 stated value authorized,
2 000 shares issued
2,000
$ 2,000
2 000
Contributed capital in excess of stated value
4,000
Total contributed capital
6,000
Retained earnings
27,000
Total shareholders’ equity
$33,000
$800,000
Shares may be issued for services, such as
compensation to lawyers, or for non-cash assets,
such as land.
When common shares are issued for services or
non-cash assets, cost is either the fair market
value
l off the
h consideration
id
i given
i
up or the
h
consideration received, whichever is more clearly
determinable.
REACQUIRED SHARES


Reacquired shares are a corporation’s own shares that have been issued, fully
paid for, and then reacquired by the corporation. (A corporation, being a
legal person, can buy and own any asset, including stock in other firms or
itself!)
In Canada, Reacquired shares are generally retired and cancelled.
– Federally incorporated firms must retire and cancel reacquired shares,
effectively returning them to the status of authorized but unissued shares.
Reacquisition and Retirement of Shares:
Date
Account Title and Explanation
March 1, 2001 Common Shares
Cash
To record reacquisition and retirement of 20,000 common shares.

Post Ref.
Debit
80,000.00 Credit
80,000.00 In certain restricted circumstances, these shares are not retired, but are held as
treasury shares for later reissue. “Treasury Shares” are a contra-equity account,
meaning that it has a debit balance and is shown as a negative component of
stockholders' equity on the balance sheet.
Reacquisition and Holding of Shares:
Date
Account Title and Explanation
March 1, 2001 Treasury Shares ‐ Common
Cash
To record reacquisition and holding of 20,000 common shares.
Post Ref.
Debit
80,000.00 Credit
80,000.00 Page 4
REACQUISITION OF SHARES
REACQUISITION OF SHARES

Why would a company choose to
reacquire its shares?
– Reduce q
quantity/raise
y
share p
price
– Increase earnings per share (EPS)
– If authorized share limit reached, may need
additional shares for use in bonus or
compensation plans or acquisitions
PREFERRED SHARE
PREFERENCES
PREFERRED SHARES



Preferred shares have priority over common
shares with regards to:
1. Dividends and
2 Assets
2.
A
iin the
h event off li
liquidation
id i
Preferred shareholders usually do not have
voting rights
Preferred shares are shown first in the share
capital section of shareholders' equity
Liquidation preference
Cumulative (dividends in arrears)
 Convertible (option to exchange for
common)
 Redeemable/callable (company option to
buy back at future for specified price)
 Retractable (shareholder option to sell
back at future for specified price)


DIVIDEND PREFERENCES
CUMULATIVE DIVIDEND



A cumulative dividend requires that preferred
shareholders be paid both current and prior year
dividends before common shareholders receive any
dividends.
Preferred dividends not declared in a given period are
called dividends in arrears.
Dividends in arrears are not considered a liability, but
the amount of the dividends in arrears should be
disclosed in the notes to the financial statements.
CONVERTIBLE PREFERRED
SHARES





Convertible preferred shares allow the exchange
of preferred shares into common shares at a
specified ratio.
This kind of share is purchased by investors who
want the greater security of a preferred share,
share but
who also desire the added option of conversion.
In recording the conversion, the book value of the
preferred shares is used.
The conversion of preferred shares does not result
in either gain or loss to the corporation.
The market value of the shares is not considered.
Page 5
REDEEMABLE PREFERRED



Redeemable (callable) preferred shares grant the issuing
corporation the right to purchase the shares from
shareholders at specified future dates and prices.
This call feature allows some flexibility to a corporation
by enabling it to eliminate this type of equity when
it is advantageous to do so.
so
While convertible shares are for the
benefit of the shareholder, redeemable
shares are for the benefit of the
corporation.
RETRACTABLE PREFERRED




Retractable preferred shares are similar to
redeemable preferred shares except that the
shareholder can redeem shares at their option instead
of the corporation’s.
Retractable preferred shares and debt have many
similarities.
similarities
Both offer a rate of return to the investor, and with
the redemption of the shares they both offer a
repayment of the principal investment.
Retractable preferred shares are presented in the
liability section of the balance sheet rather than in the
equity section because it has more of the features of
debt than equity.
REMINDER-REMINDER
STATEMENT PRESENTATION OF
SHAREHOLDERS’ EQUITY


In the shareholders’ equity section of the balance
sheet, contributed capital and retained earnings
are reported and the specific sources of
contributed capital are identified.
Within contributed capital, two classifications are
recognized:
1. Share capital
2. Additional contributed capital
ILLUSTRATION 14
14--10
SHAREHOLDERS’ EQUITY
PRESENTATION
ZABOSCHUK INC.
Partial Balance Sheet
Shareholders’ equity
Contributed capital
Share capital
$9 preferred
f
d shares,
h
no-par value,
l
cumulative, 10,000 shares authorized,
6,000 shares issued
$ 770,000
Common shares, $5 stated value, unlimited shares
authorized, 400,000 shares issued
2,000,000
Total share capital
2,770,000
Additional contributed capital
Contributed capital in excess of stated value - common shares
860,000
Total contributed capital
3,630,000
Retained earnings
1,058,000
Total shareholders’ equity
$4,688,000
RETURN ON EQUITY
BOOK VALUE PER SHARE
Return on equity (or return on
investment) is considered to be the most
important measure of a firm’s
profitability
p
y and efficiency.
y
 Evaluates how many dollars were earned
for each dollar invested by the owners.

Net Income

Average
Shareholders
Equity
=
Return on
Equity


Book value per share represents the equity a
common shareholder has in the net assets of
the corporation from owning one share.
The formula for calculating book value per
share when a corporation has only one class of
shares is:
Total
Shareholders’
Equity

Number of
Common
Shares
=
Book Value
per Share
Page 6
CALCULATION OF BOOK VALUE
WITH PREFERRED SHARES
When a company has both preferred and common
shares, the calculation of book value is more complex.
Steps required are:
1. Calculate the preferred shareholders’ equity (the sum of
redemption price of preferred shares plus any
cumulative dividends in arrears).
2. Determine the common shareholders’ equity (total
shareholders’ equity less preferred shareholders’
equity).
3. Divide common shareholders’ equity by the number of
common shares to determine book value per share.
BOOK VALUE VS. MARKET VALUE



Book value per share seldom equals market value.
Book value is based on historical costs; market
value reflects the subjective judgement of
thousands of shareholders and prospective
investors about the company’s potential for future
earnings and dividends.
Market value per share may exceed book value per
share, but that fact does not necessarily mean that
the shares are overpriced.
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Copyright © 2002 John Wiley & Sons Canada, Ltd. All rights reserved.
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