Intermediate Accounting
Thomas H. Beechy
Schulich School of Business,
York University
Joan E. D. Conrod
Faculty of Management,
Dalhousie University
PowerPoint slides by:
Bruce W. MacLean,
Faculty of Management,
Dalhousie University
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14
Chapter 14
Shareholders’ Equity
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The Corporate Form Of Organization
Advantages And Disadvantages
The primary advantages are:
Limited liability.
Capital accumulation. from
investors with diverse investment
objectives are possible
Ease of ownership transfer. The
continuity, transfer, expansion, and
contraction of ownership interests.
Potential for an expanded equity
base. issue debt or equity securities
to the public.
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These disadvantages include:
Increased taxation. There is the
potential of double taxation for
the owner-managers of
corporations.
Difficulties of control. shares are
held by a diverse group
Limited power of minority
shareholders. can be outvoted
by the majority shareholders
Cost to operate. Legal and
accounting fees are generally
higher.
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Private Vs. Public Corporations
Federal and provincial legislation
governs the formation and operation
of corporations; a corporation may
be formed either provincially or
federally
About half of the 300 Canadian
public companies surveyed by
Financial Reporting in Canada 1995
are incorporated federally. Another
25% of the survey companies are
incorporated in Ontario, while the
rest are spread among the other
provinces
Canada Business Corporations Act,
1975
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Private companies have a limited
number of shareholders
(maximum of 50 by the provincial
securities acts) and the shares
cannot be publicly traded. Private
corporations generally have a
shareholders’ agreement
the 50% Finanncial Post list of the
500 largest Canadian corporations
are private
Public companies are those
whose securities, either debt or
equity, are traded on stock
exchanges
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Share Capital
Share capital, represented by share
certificates, represent ownership in a
corporation. Shares may be bought,
sold, or otherwise transferred by the
shareholders without the consent of
the corporation unless there is an
enforceable agreement to the contrary
Classes of shares
At least one class of shares has the
right to vote, and that class receives
the residual interest (if any) in the
assets if the company is liquidated or
dissolved. This class of shares
normally is described as the common
shares
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Preferred shares are so
designated because they confer
certain preferences, or
differences, over common shares.
• Voting rights..
• Dividends.Cumulative,
participation in dividends.
• Assets upon liquidation
• Convertibility to other
securities.
• Guarantee. return of their
invested amount
Restricted shares or special
shares
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Par Value Versus No-Par Value Shares
While the CBCA and most provincial
business corporations acts prohibit
the use of par value shares, one or
two provincial jurisdictions do allow
their issuance.
Par value shares
– have a designated dollar amount per
share, as stated in the articles of
incorporation and as printed on the
face of the share certificates. Par
value shares may be either common
or preferred
– less than par are issued at a
discount. above par are issued at a
premium.
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No-par shares do not carry a
designated or assigned value
per share
Only 7% of Canadian public
companies surveyed by
Financial Reporting in Canada
1997 reported a par (or stated)
value
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Fundamental Share Equity Concepts And
Distinctions
Separate legal entity. nonpersonal
entity that may own assets, owe debts,
and conduct operations as an
independent entity separate from each
shareholder.
Sources of shareholders' equity. The
primary sources of shareholders' equity
are organized, accounted for, and
reported separately on the balance
sheet to provide useful data for financial
statement users.
• Contributed capital from
shareholders..
• Retained earnings.
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•
•
•
•
•
•
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Cost-base accounting.
Authorized share capital. The
maximum number of shares
that can be legally issued.
Issued share capital..
Unissued share capital
authorized - issued
Outstanding share capital.
issued and currently owned by
shareholders.
Treasury shares. Outstanding
shares reacquired.
Subscribed shares. Unissued
shares set aside for contracts
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EXHIBIT 14-1
Example of Shareholders’ Equity Section – Royal
Bank of Canada, 1997
Shareholders’ equity (in
millions of dollars)
Capital stock
Preferred
Common
Retained earnings
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1997
$
1,784
2,907
5,699
$ 10,390
1996
$
$
1,752
2,876
4,786
9,414
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Accounting For Share Capital At Issuance
Authorization. The articles of incorporation will authorize an unlimited
(or, less frequently, a limited) number of shares. This authorization may
be recorded as a memo entry in the general journal and in the ledger
account by the following notation:
– Common Shares – No-par Value (Authorized: Unlimited Shares)
No-par Value Shares Issued for Cash. When shares are issued, a
share certificate, specifying the number of shares represented, is
prepared for each shareholder. An entry reflecting the number of shares
held by each shareholder is made in the shareholder ledger, a
subsidiary ledger to the share capital account.
Th e iss uan ce o f 1 0, 00 0 com m on sh ares, n o-p ar, for cash of $1 0 .20 p er sh are
C as h
1 02 ,0 00
C o m m o n s hares , n o par value (10 ,0 00 sh ares)
1 02 ,0 00
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Accounting For Share Capital At Issuance
Shares Sold on a Subscription Basis. Prospective shareholders may
sign a contract to purchase a specified number of shares on credit, with
payment due at one or more specified future dates
1 20 n o -par c ommo n s ha res o f B T C o rp oratio n ar e su bs cribed for at $12 b y J. Do e.
The total is p ayable in th ree ins talme nts of $4 80 each .
S to ck s u bs crip tion s re ceivable – co mmo n s har es (D oe )
1 ,4 40 *
C ommon s ha res s ub sc rib ed , n o-p ar (1 20 sh ares )
1 ,4 40
To record the collection:
Cash
Stock subscriptions receivable – common shares (Doe)
To record issuance of shares:
Common shares subscribed, no-par (120 shares)
Common shares, no-par (120 shares)
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480
480
1,440
1,440
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Accounting For Share Capital At Issuance
Default on Subscriptions. When a subscriber defaults after partial
fulfilment of the subscription contract, certain complexities arise. In case
of default, the corporation may decide to (1) return all payments
received to the subscriber; (2) issue shares equivalent to the number
paid for in full, rather than the total number subscribed; or (3) keep the
moneys received.
Non-Cash
Sale
of Share
Capital.
Corporations
sometimes
To illustrate,
assume
that Bronex
Corp.
issued 136,000
Class A issue
sharesshare
in
capital
forfor
non-cash
assets
When
a corporation
issues
its the
shares
for
exchange
land. The
land .was
appraised
at $420,000,
while
shares,
non-cash
assets
or services
or toinsettle
debt, the
should be
based on the
one prior
transaction
the shares,
weretransaction
valued at $450,000.
recorded
fair value
– but
there are
two fairthe
values
present,
the fair
The boardatofthe
directors
passed
a motion
approving
issuance
of shares
value
of the asset
received,
value
of the shares issued.
to be valued
at the average
of and
thesethe
twofair
prices,
$435,000.
Land
435,000
Class A share capital (136,000 shares)
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435,000
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Accounting For Share Capital At Issuance
Share Issue Costs. Corporations often incur substantial expenditures
when they issue shares in a public offering. These expenditures include
registration fees, underwriter commissions, legal and accounting fees,
printing costs, clerical costs, and promotional costs. These expenditures
are called share issue costs.
– Offset method. Under this method, share issue costs are treated as
a reduction of the amount received from the sale of the related share
capital.
– Retained Earnings method. Companies will charge share issue
costs directly to retained earnings in a variation of the offset
method..
– Deferred charge method. Under this method, share issue costs are
recorded as a deferred charge and are then amortized over a
‘reasonable’ period. All methods are found in practice, although the
deferred charge method is less common.
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Retirement Of Shares
Some preferred shared are retractable,
which means that, at the option of the
shareholder, and at a contractually
arranged price, a company is required to
buy back its shares.
Other preferred shares are callable, or
redeemable, which means that there are
specific buy-back provisions, at the option
of the company. In these transactions, the
company deals directly with the
shareholder.
However, a company can buy back any of
its shares, preferred or common, at any
time, if they are offered for sale.
Such a sale can be a private transaction,
or a public (stock market) transaction
Copyright  1998 McGraw-Hill Ryerson Limited, Canada
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To increase earnings per share
(EPS). EPS is the ratio obtained by
dividing net income by outstanding
shares. EPS increases, so should
market price
To provide cash flow to shareholders
in lieu of dividends
To acquire shares when they appear
to be undervalued.
To buy out one or more particular
shareholders and to thwart take-over
bids.
To reduce future dividend payments
by reducing the shares outstanding.
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Retained Earnings
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Decreases (debits):
•
Net loss (including extraordinary
items)
Error correction (may also be a credit)•
Effect a change in accounting policy
applied retroactively (may also be a •
credit)
Cash and other dividends
Stock dividends
Share retirement and treasury stock
transactions
Share issue costs
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Increases (credits):
Net income (including
extraordinary items)
Removal of deficit in a financial
reorganization
Unrealized appreciation of
investments valued at market
(such as by an investment
fund)
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Appropriations And Restrictions
Of Retained Earnings
Appropriated retained earnings are the result of discretionary
management action.
Restricted retained earnings are the result of a legal contract or
corporate law.
• To fulfil a contractual agreement, as in the case of a debt covenant
restricting the use of retained earnings for dividends that would result
in the disbursement of assets.
• To report a discretionary appropriation made to constrain a specified
portion of retained earnings as an aspect of financial planning.
• To report a discretionary appropriation of a specified portion of
retained earnings in anticipation of possible future losses.
• To fulfil a legal requirement, as in the case of a provincial corporate
law requiring a restriction on retained earnings equivalent to the cost
of treasury stock held.
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Reporting Retained Earnings
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1. Beginning balance of retained earnings.
2. Restatement of beginning balance for
error corrections.
3. Restatement of beginning balance for
retroactively applied accounting changes.
4. Net income or loss for the period.
5. Dividends declared for the period.
6. Appropriations and restrictions of retained
earnings (may alternatively be disclosed in the
notes).
7. Adjustments made pursuant to a financial reorganization.
8. Adjustments resulting from some share retirements.
9. Ending balance of retained earnings.
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Dividends
A dividend is a distribution of earnings to shareholders in
the form of assets or shares. A dividend typically results
in a credit to the account that represents the item
distributed (cash, non-cash asset, or share capital) and a
debit to retained earnings.
Instead of paying a dividend, the corporation may want
to:
•
•
•
Conserve cash for immediate use.
Expand, grow, and modernize by investing in new assets.
Provide a cushion of resources to minimize the effect of a
recession or various unforeseen contingencies.
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Relevant Dividend Dates
Date of Declaration. On this date, the corporation's board of
directors formally announces the dividend declaration.
Date of Record. . The date of record is the date on which the list of
shareholders of record is prepared. Individuals holding shares at this
date, as shown in the corporation's shareholders' record, receive the
dividend, regardless of sales or purchases of shares after this date
Ex-Dividend Date. Technically, the ex-dividend date is the day
following the date of record
Date of Payment. This date is also determined by the board of
directors and is usually stated in the declaration. The date of
payment typically follows the declaration date by four to six weeks
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Legality Of Dividends
(1) dividends may not be paid from legal capital (usually
represented in the share capital accounts) without
permission from creditors, and
(2) retained earnings are available for dividends unless
there is a contractual or statutory restriction.
Under the Canada Business Corporations Act, a liquidity
test must also be met: Dividends may not be declared or
paid if the result would be that the corporation became
unable to meet its liabilities as they came due, or if the
dividend resulted in the realizable value of assets being
less than liabilities plus stated capital.
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Cumulative Dividend Preferences On Preferred
Shares
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Cumulative preferred shares provide that dividends not
declared in a given year accumulate at the specified rate on
such shares.
This accumulated amount must be paid in full if and when
dividends are declared in a later year before any dividends
can be paid on the common.
If cumulative preference dividends are not declared in a given
year, they are said to have been passed and are called
dividends in arrears on the cumulative preferred shares.
The CICA Handbook requires that arrears of dividends for
cumulative preference shares be disclosed, usually in the
notes to the financial statements.
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Property Dividends And Spin-Offs
Dividends with non-cash assets.
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Property dividends or dividends in
kind.
The property may be investments in
the securities of other companies held
by the corporation, real estate,
merchandise, or any other non-cash
asset designated by the B of D
A property dividend is recorded at the
current market value of the assets
transferred.
Book value different from its market
value - recognize a gain or loss on
disposal of the asset as of the
declaration data
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Spin-off, in which the shares of
a wholly or substantially owned
subsidiary are distributed to the
parent company's shareholders.
The parent company's
shareholders now directly own
the subsidiary rather than
exercise control indirectly
through the corporation.
Since a spin-off is a splitting up
of a reporting entity, the spin-off
is usually valued at the book
value of the spun off shares, not
at market value.
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Liquidating Dividends
Distributions that are a return of the amount received when shares
were issued, rather than assets acquired through earnings, are
called liquidating dividends. Owner's equity accounts other than
retained earnings are debited. Since such dividends reduce
contributed capital, they typically require creditor approval.
Liquidating dividends are appropriate when there is no intention or
opportunity to conserve resources for asset replacement. A mining
company might pay such a liquidating dividend when it is exploiting
a nonreplaceable asset.
Shareholders must be informed of the portion of any dividend that
represents a return of capital, since the liquidation portion of the
dividend is not income to the investor and is usually not taxable as
income; it reduces the cost basis of the shares.
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Scrip Dividends
A corporation that has a temporary cash shortage might declare a
dividend to maintain a continuing dividend policy by issuing a scrip
dividend.
A scrip dividend (also called a liability dividend) occurs when the
board of directors declares a dividend and issues promissory notes,
called scrip, to the shareholders.
This declaration means that a relatively long time (e.g., six months
or one year) will elapse between the declaration and payment dates.
In most cases, scrip dividends are declared when a corporation has
sufficient retained earnings as a basis for dividends but is short of
cash.
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Accounting Issues Related To Stock Dividends
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The two primary issues in accounting for stock dividends are the
value that should be recognized and the timing of accounting
recognition.
Accountants disagree about the value that should be used in
recognizing stock dividends. The shares issued for the dividend could
be recorded at market value, at stated (or par) value, or at some other
value.
The AcSB has made no recommendation on the matter; however, the
Canada Business Corporations Act requires shares to be issued at
fair market value. In Ontario, on the other hand, legislation permits the
board of directors to capitalize any amount it desires. In the United
States, small stock dividends (i.e., less than 20 to 25% of the
outstanding shares) must be recorded at market value, while large
stock dividends are recorded only as a memo entry.
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Special Stock Dividends
A special stock dividend is a dividend in a share class different
from the class held by the recipients, such as a stock dividend
consisting of preferred shares issued to common shareholders. In
this case, the market value of the dividend (the preferred shares)
should be capitalized.
When a stock dividend is issued, not all shareholders may own
exactly the number of shares needed to receive whole shares. For
example, when a firm issues a 5% stock dividend and a shareholder
owns 30 shares, the shareholder is entitled to 1.5 shares (30 × 5%).
When this happens, the firm may issue fractional share rights for
portions of shares to which individual shareholders are entitled
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Stock Splits
A stock split is a change in the number of shares outstanding with no
change in the recorded capital accounts. A stock split usually increases
the number of shares outstanding by a significant amount, such as
doubling or tripling the number of outstanding shares. The primary
purpose of a stock split is to increase the number of shares outstanding
and decrease the market price per share, increase the market activity of
the shares, reduce earnings per share.
In contrast, a reverse stock split decreases the number of shares. It
results in a proportional reduction in the number of shares issued and
outstanding and an increase in the average book value per share.
Reverse splits may be used to increase the market price of so-called
penny stocks, often in preparation for a new public offering of shares. The
proportions of a reverse split can be dramatic, such as the 1-for-1,000
stock split announced by Ottawa Structural Steel in 1996
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EXHIBIT 14-3
Split Corporation − Stock Dividend and Stock Split
Compared
Total Prior to
Share Issue
Initial issue 40,000 × $10 =
100% stock dividend: 80,000 × $10 =
Two-for-one stock split: 80,000 × $5 =
Total contributed capital
Retained earnings
Total shareholders' equity
After 100%
Stock
Dividend
After
200% Stock
Split
$400,000
$800,000*
400,000
450,000
$850,000
800,000*
50,000*
$850,000*
$400,000
400,000
450,000
$850,000
*Retained earnings capitalized: 40,000 shares × $10 = $400,000;
entry:
debit retained earnings, $400,000;
credit contributed capital accounts, $400,000.
After the stock dividend, contributed capital equals $800,000, which is
$400,000 + $400,000.
Retained earnings is $450,000 − $400,000, or $50,000.
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Exhibit 14-4 Additional Contributed Capital
■
Decrease:
■
Retirement of shares at a price
greater than average issue price to ■
date, when previous contributed
capital has been recorded.
Treasury stock transactions, shares ■
issued below cost, when previous
contributed capital has been
recorded.
■
In a financial restructuring (explained
in the Appendix to Chapter 15).
Copyright  1998 McGraw-Hill Ryerson Limited, Canada
Increase:
Receipt of donated assets.
Retirement of shares at a price
less than average issue price
to date.
Issue of par value shares at a
price or assigned value higher
than par.
Treasury stock transactions,
shares reissued above cost
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Other Components Of Shareholders’ Equity
Comprehensive revaluation of assets
and liabilities from cost to market value.
Only permitted when there is:
Comprehensive revaluation is
discussed more fully in Chapter 11.
A change in control such that the
controlling shareholder has 90% or
more of equity interests, or
A financial reorganization signalling a
fresh start for the entity following
receivership or bankruptcy or following
a voluntary restructuring agreement
with the corporation’s creditors and
shareholders
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Cumulative foreign currency
translation account. This item
represents unrealized gains and
losses that arise from a certain
type of foreign currency
exposure.
Finally, life insurance and mutual
fund companies, which are
required to carry their investment
assets at market values, will
report an unrealized capital
increment that represents the
difference between the cost and
the market value of their
investments
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Shareholders’ Equity Disclosure
Corporations must disclose the changes in their equity
accounts that take place during the year.
In particular, companies must disclose the changes in
share capital accounts in terms of the number of shares
issued, repurchased, and retired and the dollar amount
assigned to the transactions.
Changes in contributed capital must be clearly disclosed.
Some companies do this in a disclosure note, but many
present a schedule or statement to demonstrate
continuity from one year to the next
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