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Chapter 10
Shareholders’ Equity
Learning Objective 1Explain the features of a corporation
2Copyright ©2014 Pearson Education.
Corporate CharacteristicsADVANTAGES DISADVANTAGES• Can raise more
capital• Continuous life• Ease of transferring
ownership• Limited liability of
shareholders
• Separation of ownership and management
• Corporate taxation• Government
regulation
3Copyright ©2014 Pearson Education.
Organizing a Corporation•Corporate organizers (incorporators)
obtain a charter from the government▫Charter includes authorization to issue
shares•Incorporators:
▫Pay fees▫Sign the charter▫File documents with the state▫Agree to set of bylaws
•In Hong Kong, see www.cr.gov.hk4Copyright ©2014 Pearson Education.
Copyright ©2014 Pearson Education. 5
Shareholders (Owners)
Chief Executive Officer (CEO)
Board of Directors (elected by SH)
Chief Operating Officer (COO)
Director, Sales
Chief Financial Officer
Company Secretary
Controller Treasurer
Director, Personnel
Director, Manufacturi
ng
Shareholder Rights
Vote Dividends
Liquidation
Preemption
6Copyright ©2014 Pearson Education.
7Copyright ©2014 Pearson Education.
Shareholder Rights• 1. Vote.
▫ The right to participate in management by voting on matters that come before the shareholders. This is the shareholder’s sole voice in the management of the corporation.
• 2. Dividends. ▫ The right to receive a proportionate part of any dividend, if declared by
the board. Each share in a particular class receives an equal dividend.• 3. Liquidation.
▫ The right to receive a proportionate share of any assets remaining after the corporation pays its liabilities in liquidation. Liquidation means to go out of business, sell the assets, pay all liabilities, and distribute any remaining cash to the owners.
• 4. Preemption. ▫ The right to maintain one’s proportionate ownership in the corporation.
Sometimes required by law, sometimes company grant this right.
Shareholders’ EquityPaid-in capital
• Amount shareholders have contributed
Retained earnings
• Amount earned by profitable operations
8Copyright ©2014 Pearson Education.
Classes of SharesORDINARY PREFERENCE• Basic form of share
capital• Has four basic rights• Shareholders benefit
most if corporation succeeds▫ Take more risk
• Has advantages over common▫ Receive dividends first▫ Receive assets first in
liquidation• Shareholders earn a fixed
dividend• Very few corporations
(7%) issue • Disadvantage
▫ Sometimes does not have voting right
9Copyright ©2014 Pearson Education.
Comparison of Issuing Shares and Debt
Copyright ©2014 Pearson Education. 10
Ordinary share
Preference share
Long-term debt
Obligation to repay principal
No No Yes
Dividends/interest Dividends are not tax deductible
Dividends are not tax deductible
Interest expense is tax deductible
Obligation to pay dividends/interest
Only after declaration
Only after declaration
At fixed rates and date
Par Value•________ amount assigned to a share•Usually set low to avoid legal issues•No-par shares
▫May have a stated value
11Copyright ©2014 Pearson Education.
Learning Objective TwoAccount for the issuance of shares
12Copyright ©2014 Pearson Education.
Ordinary Shares at Par•DR Cash • CR Ordinary Shares•Ex: Issue 6,200,000 shares of $10 par
stock for $10 each.
13Copyright ©2014 Pearson Education.
JOURNALDate Accounts and explanation Debit Credit
Cash (__________) ________ Ordinary shares ________To issue ordinary shares.
Ordinary Shares above Par•DR Cash (shares * sale price)
• CR Ordinary Shares (shares * par value)
• CR Additional Paid-in Capital (shares*(sale price – par))
•Ex: Issue 6,200,000 shares of $0.01 par stock for $10 each.
14Copyright ©2014 Pearson Education.
JOURNALDate
Accounts and explanation Debit Credit
Cash 62,0000,000 Ordinary shares 62,000 Paid-in capital in excess of par
61,938,000
To issue ordinary shares above par
Ordinary Shares with No-Par Values•Dr Cash (shares * price)• Cr Share capital (shares * price)•Ex: Sell X shares for $2,893,154
15Copyright ©2014 Pearson Education.
JOURNALDate
Accounts and explanation Debit Credit
Cash 2,893,154 Share capital 2,893,154To record issuance of no-par shares.
Shares Issued for Non-Cash Assets•Asset received is recorded at current
market value•Ex: Exchange 15,000 shares of $1 par for
equipment worth 4,000 and building worth 120,000
16Copyright ©2014 Pearson Education.
JOURNALDate
Accounts and explanation Debit Credit
Equipment ______Building ______ Ordinary Shares ______ Paid-in capital in excess of par ______To issue $1 par shares in exchange for equipment and a building
Shares Issued for Services•Asset received is recorded at current
market value•Ex: Company hires lawyer to represent
the company. The services are for $25,000. In return, the lawyer accepts 2,500 shares of $1 par common stock with $10/share market value.
17Copyright ©2014 Pearson Education.
JOURNALDate
Accounts and explanation Debit Credit
Legal expense ______ Ordinary Shares ______ Paid-in capital in excess of par ______
Preference Shares•Follows same pattern as accounting for
ordinary shares•May have separate accounts for paid-in
capital in excess of par for preferred shares
•Can be issued with conversion feature▫Allows preferred shareholders to exchange
preferred shares for ordinary shares
18Copyright ©2014 Pearson Education.
Number of Shares
Authorized Issued
Outstanding
19Copyright ©2014 Pearson Education.
20Copyright ©2014 Pearson Education.
Number of Shares•Authorized
▫Total number of shares the company is permitted to offer (registered with government)
•Issued▫Number of shares sold to shareholders
•Outstanding▫Number of shares sold and not redeemed
or cancelled
Learning Objective ThreeDescribe how treasury shares affects a company
21Copyright ©2014 Pearson Education.
Treasury Share•Issued shares __________by the company•Reasons:
▫Make shares available for employee share purchase plans
▫Plan to “buy low” and “sell high”▫Avoid takeover▫Increase earnings per share
•In this class, we will not cover Treasury Shares in detail
22Copyright ©2014 Pearson Education.
Retained EarningsCumulativ
e Net income
Net losses
Dividends declared
23Copyright ©2014 Pearson Education.
Retained Earnings Balance
Copyright ©2014 Pearson Education. 24
Credit balance
Lifetime earnings
Lifetime losses & dividends>
Debit balance
Lifetime earnings
Lifetime losses & dividends
<
Learning Objective FourAccount for dividends
25Copyright ©2014 Pearson Education.
Cash Dividends• Company must have both:
▫Enough Retained earnings to declare the dividend
▫Enough Cash to pay the dividend▫DR_______________▫ CR ________________
• Two types of dividends:▫Final dividend
Declared after the end of financial year and company’s AGM
Recommended by board of directors and require approval by shareholders
▫Interim dividends Declared during the year Declared by board of directors 26Copyright ©2014 Pearson Education.
Learning Objective FiveUse share values in decision making
27Copyright ©2014 Pearson Education.
Share Values•Price of a share in the marketMarket value
•Price a company agrees to pay on redemption of the share
Redemption value
•Amount paid to a preference shareholder during liquidation
Liquidation value
•Amount of owner’s equity on the company’s booksBook value
28Copyright ©2014 Pearson Education.
Learning Objective SixCompute earnings per share and return on equity
29Copyright ©2014 Pearson Education.
Earnings Per Share
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Net income – Preference Dividends
Average number of shares
(Beginning total shares + Ending total shares)/2
Return on Equity
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Net income – Preference dividends
Average ordinary shareholders’ equity
(Beginning ordinary shareholder equity+ Ending ordinary shareholder s’equity)/2
Learning Objective SevenReport equity transactions on the statement of cash flows
32Copyright ©2014 Pearson Education.
Equity Transactions on the Cash Flow Statement
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Consolidated Cash Flow StatementCash flows from operating activities $XXX Cash flows from investing activities XXXCash flows from financing activities Payment for share issuance costs (XXX) Payment for repurchase of shares (XXX) Proceeds from issuance of shares
XXX
Dividends paid (XXX)XXX
Net cash flows XXX