Companies: Share Capital and the Statement of Financial Position

Companies: Share Capital and the

Statement of Financial Position

Chapter 14

HORNGREN ♦ HARRISON ♦ BAMBER ♦ BEST ♦ FRASER ♦ WILLETT

14 - 2Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia

Objectives1.Identify the characteristics of a company.2.Record the issue of shares3.Prepare the shareholders’ equity section of a

company’s statement of financial position4.Account for cash dividends5.Use different share values in decision-making6.Evaluate a company’s return on assets and

return on shareholders’ equity7.Account for the income tax of a company


Objective 1

Identify the characteristicsof a company.


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


Organising 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 the company.

The company can accept these rules or replace them with their own company constitution.


Organising a company

Shareholders elect the board of directors. The board sets policy, appoints the

officers, and elects a chairperson. The board also designates the managing

director, who is often known as the chief executive officer (CEO).


Authority Structurein a Company

Shareholders

Board of Directors

Chairperson of the Board

Chief Executive Officer

Various Executives and Company Secretary

Controller? Treasurer?


Share Capital

Company ownership is evidenced by a ‘share certificate’ or ‘shareholder holding statement’ which may be for any number of shares.

See Exhibit 14-3 and 14-4 in your textbook A share that is held by a shareholder is

said to be an ‘issued share’.


Shareholders’ Equity

Share capital

Retained profits

Owners’ equity in the companyhas two components:


Shareholders’ Equity Example

On June 1, the Wong’s companyissued share valued at $10,000.

June 1Cash 10,000

Share Capital 10,000Issue of share


Shareholders’ Equity Example

Wong’s company net profitfor the year was $8,000.

June 30 Profit and Loss Summary 8,000

Retained Profits 8,000 To close net profit to Retained Profits


Shareholders’ Rights

The ownership of share entitles shareholders to four basic rights, unless specific rights are withheld by agreement.

1 Vote2 Dividends3 Liquidation4 Preemption


Classes of share

Ordinary share is the most basic form of capital share.

Preference share gives its owners certain advantages over ordinary shareholders.

In Australia shares are now issued without a par value (it makes the accounting easier).


Objective 2

Record the issue of shares.


Issuing Shares Example

On January 13, Martin Limited, which manufactures skateboards, issues 10,000 ordinary share for $10 per share.



The 10,000 shares were issued for $10 each.

January 13Cash 100,000

Ordinary Share Capital 100,000

Issue no par value ordinary share



On February 11, Martin company issued 15,000 shares of its ordinary share for a building worth $100,000.

What is the journal entry?



February 11Building 100,000

Ordinary Share Capital (15,000 shares)100,000Issued ordinary share in exchange for a building


Issuing Shares ExampleBy 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


Issuing Shares ExampleBy Instalment

Huang Limited issues 10,000 shares $5 payable on application $3 on allotment and $2 call.



Applications received for 10,000shares

Cash Trust (10,000 x $5) 50,000Application 50,000

Received application money, to be held in trust



The 10,000 shares were issued (allotted).

Application (10,000 x $5) 50,000Allotment (10,000 x $3) 30,000

Ordinary Share Capital 80,000

Issue ordinary share



The application money is now ours, so it can be transferred from the trust account

to our account .

Cash 50,000Cash Trust 50,000

Transfer application money to company’s bank account



Received allotment money

Cash 30,000Allotment 30,000

Collected amount due on allotment



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


Issuing Shares ExampleOversubscription

Investors may apply for more shares than are available to be issues.

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)



OrApplication 10,000

Allotment 10,000Apply excess application money to amountdue on allotment

Application 10,000Cash Trust 10,000

Refund excess application money


Issuing Shares ExampleForfeiture

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

The “Call” account was originally debited $20,000

But only $19,800 cash was received



Ordinary Share Capital (100 x $10) 300Call (100 x $2) 300Forfeited Share Account 700

Record forfeiture of 100 shares

To forfeit the shares



Cash 950Forfeited Share Account 50

Ordinary Share Capital 1,000Reissued 100 forfeited shares

The forfeited shares were reissued for $9.50 each


Issuing Preference share

Accounting for preference share follows the pattern illustrated for ordinary share.

Shareholders’ equity on the statement of financial position lists, ordinary share, preference share, and retained profit – in that order.


Objective 3

Prepare the shareholders’equity section of a company’s statement of financial position.


Contributed equity: 400 ordinary shares, fully paid 4,000 100 preference shares (70c per share annual dividend) fully paid 2,000Retained profits 3,000

Total equity 9,000

Review of Accountingfor Paid-up Capital



Review of Accountingfor Paid-up 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 – but has become the shareholders’.


Objective 4

Account for cash dividends.


Dividend Dates

A company must declare a dividend before paying it.

The board of directors alone has the authority to declare a dividend.


Dividend Dates

Declaration date

Date of record Payment date

Three relevant dates for dividends are:


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.



June 15Dividends Payable 60,000

Cash 60,000Paid a cash dividend

April 1Retained Profits 60,000

Dividends Payable 60,000Declared a cash dividend



1,000 Preference shares $6 annual dividend per share

25,000 Ordinary shares

$50,000 dividends declared



Preference dividend$6 × 1,000 = $6,000

Ordinary dividend $50,000 – $6,000 = $44,000


Preference dividend$6 × 10,000 = $60,000

(The full $50,000 goes to preference shares)

Suppose there were 10,000 preference shares, $6 annual dividend per share

Ordinary shareholders receive nothing.



Cumulative and Non-cumulativePreference Shares

If the preference is cumulative, the $10,000 shortage must be paid before any dividend is paid to ordinary shareholders.

If noncumulative, a passed dividend not paid or not fully paid is simply lost.


Objective 5

Use different share valuesin decision-making.


Share Values

The business community refers to different share values in addition to the original issue price.

– market value– liquidation value– book value


Share Values Example

Book value preference =(Liquidation value + Dividends in arrears)

÷ Number of shares outstanding

Book value per share =Total shareholders’ equity ÷ Total shares outstanding

Book value ordinary =(Shareholders’ equity – Amount allocated to preference)

÷ Number of shares outstanding



Contributed Equity:Ordinary share, 10,000 shares, fully paid $300,000

Retained profits 100,000

Total shareholders’ equity $400,000

Book value per share: $400,000 ÷ 10,000 = $40




Book value per share preference:($210,000 + $12,000) ÷ 2,000 = $111.00liquidation + 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


Objective 6

Evaluate a company’s returnon assets and return on

shareholders’ equity.


Return on Assets

Rate of return on total assets =Earnings before (interest + tax)

÷ Average total assets

It is a measure of a company’s ability to generate profits from the use of its assets.


Return on Equity

Rate of return on ordinary shareholders’ equity =(Net profit – Preference dividends)

÷ Average ordinary shareholders’ equity

It is a measure of the profits earnedfrom the ordinary shareholders’

investment in the company.


Objective 7

Account for the income taxof a company.


Accounting for Income Taxesby Company’s

Income tax expense =Profits before income tax

(from the statement of financial performance.) × Income tax rate

Income tax payable =Taxable income (from the tax return filed with the ATO)

× Income tax rate


Accounting for Income Taxesby Company’s

Deferred tax liability is the difference between income tax expense and income tax payable for any one year.

Revenues and expenses may be reported in different periods for statements of financial performance and tax return purposes.

Alternative depreciation methods may be used for book and tax purposes.


End of Chapter 14

Documents

Companies: Share Capital and the Statement of Financial Position