Chapter 13 Corporations Organization and Share Capital Transactions

Chapter 13 Corporations: Organization and Share Capital Transactions Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Agenda Learning goals • Vocabulary • Lesson 1: The Corporate form of organization • • • Characteristics of a corporation Forming a Corporation Ownership rights of shareholders Shares Issue Considerations Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Learning goals 1. 2. 3. 4. Identify and discuss the major characteristics of a corporation Record common shares transactions Record preferred shares transactions Prepare the shareholders’ equity of the balance sheet and calculate return on equity. Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Vocabulary • • • • Authorized shares Common shares Comprehensive income Contributed capital Convertible preferred shares Corporation Cumulative dividend Dividends in arrears Financial instrument Initial public offering (IPO) Issuing shares Legal capital No par value shares • • • Noncumulative Organization costs Preferred shares Privately held corporation Publicly held corporation Redeemable (callable) preferred shares Retained earnings Retractable preferred shares Return on equity Share capital Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

The Corporate Form of Organization • The corporation: is a legal entity that is separate form its owners, who are known as shareholders. • As a legal entity, a corporation has most of the rights and privileges of a person. • Obligation to respect laws and pay income tax • It can not vote or hold public office. • Corporation can be for profit and not for profit Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Classification by Ownership • Publicly held corporation: The shares are traded on organized securities markets, such as Toronto Stock Exchange. Available for anyone in the general public to buy or sell. • Privately held corporation: Shares are owned by a few private shareholders. The share not traded on stock exchanges and are not available to the general public. Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Characteristics of a Corporation • • • Separate legal existence from its owners Limited liability of shareholders to the amount of their investment Transferable ownership rights by buying and selling shares Ability to acquire capital by issuing shares Continuous and indefinite life Corporation management • Shareholders manage through an elected board of directors • Board of directors selects corporation management • Government regulations • Canada Business Corporation Act regulates what corporation can or can not do • Income tax • Taxed as a separate entity Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Advantages and Disadvantage of a Corporation Advantages Disadvantages • Corporate management – • Corporate professional managers management – • Separate legal existence ownership separated • Limited liability to shareholders from management • Potential for deferred or reduced • Increased cost and income tax (shareholder do not complexity to follow pay tax on income earned until it government is distributed to them) regulations • Transferable ownership rights • Potential for additional • Ability to acquire capital income tax • Continuous life Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Forming a Corporation Can incorporate federally or provincially • Done by filing articles of incorporation • • Provide information such as : • • Name and purpose of company Amounts and kinds of share capital Names and addresses of incorporators Location of corporation’s head office By-laws: internal rules and policies • Organization costs: • • Costs of forming a corporation (legal fees, accounting fees and regulation) • Normally expensed Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Ownership Rights of Shareholders • Ownership rights are in the form of shares • Can be divided into different classes • • As stated in the articles of incorporation Each class has rights and privileges Usually referred to as common and preferred shares Shareholders have rights: • • • To vote on certain matters To dividends: the distribution of income To remaining assets in a liquidation Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Share Issue Considerations • Authorized share capital • Number of shares company is allowed to sell • Many companies have unlimited number of shares • Issued shares • Authorized shares that have been sold • Issued directly to investors or through an investment dealer • First public sale is called an initial public offering (IPO) Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Share Issue Considerations 2 Market value of shares • Once issued, shares trade on a secondary market • Prices determined by buyers and sellers and other external factors • Legal capital • Is the amounts contributed to the corporations by shareholders in exchange for shares of ownership it is considered legal capital and can not be distributed to shareholders • Retained earnings are earned capital and can be distributed as dividends • Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Practice questions • • • Self study questions: 1+2 Question 3, 5, 6 BE 13 -1 & 2 E 13 -1 P 13 -1 A Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Agenda • Common Shares • • • Issuing shares for cash Reacquisition of shares Preferred shares • • • What are they Dividend preference Convertible preferred Redeemable and retractable preferred Liquidation Preference Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Common Shares: Issuing Shares • Shares are usually issued for cash: Dr. Cash Cr. Common shares • Shares can be issued in exchange for services (compensation for lawyers or consultants or noncash assets (land, building and equipment) • Recorded at market value of shares given up: Dr. Service or asset (amount = mkt value of shares) Cr. Common shares • If market value of shares not determinable, use value of services or noncash assets Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Common Shares: Issuing Shares Assume that they lawyer who helped Hydroslide incorporated billed the company $5, 000 for her services. On January 18, she agreed to accept 4, 000 common shares in payment for her bill. At the time of the exchange, the market price for the shares is $1 Jan 18 legal Fees Expense 4, 000 Common Shares 4, 000 To record issue of 4, 000 common shares for legal service Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Common Shares: Issuing Shares For noncash transactions the cost is the cash equivalent price. • This means that when there is an issue of shares in exchange for services or noncash assets, the cash equivalent price is the market value of the common shares given up • Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Common Shares: Issuing Shares When common shares do not have a ready market value (meaning they can not be bought or sold easily) or their market cannot be determined. • In these cases, the market value of the consideration that is received would instead be used to determine the cash equivalent price. • Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Common Shares: Issuing Shares Newly incorporated company issued 10, 000 shares on October 1 to acquire land with an appraised value of $80, 000. • At the time of the acquisition the company's shares do not have a reliable market value because they are not actively traded yet. • In this case, the land would be recorded at the market value of the consideration received $80, 000 Oct 1 Land 80, 000 Common shares 80, 000 To record issue of 10, 000 common shares for land • Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Common Shares: Reacquisition of Shares Companies can reacquire their shares to: • Increase trading on securities markets to increase market value • Increase earnings per share by reducing shares • Buyout hostile shareholders • Have shares available for compensation or other uses (employee and managers) • Comply with share ownership restrictions (limits of foreign ownership) • Reacquired shares are retired and cancelled • Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Common Shares: Reacquisition of Shares 2 • Steps to record a reacquisition: • Remove cost of shares from share capital account • Based on average cost per share (must be calculated) • Record cash paid for the shares • Record the gain or loss on reacquisition • Price paid to acquire the shares – original cost Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Reacquisition of Shares: Below Average Cost • Average cost of shares: = • Balance in Common Shares Account Number of Common Shares Issued If shares reacquired at a price < average cost: Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Reacquisition of Shares: Above Average Cost • If shares reacquired at a price > average cost: • Additional cost of shares is first debited to contributed capital from previous reacquisitions (only when there is a balance the account otherwise: • Remaining difference is debited to retained earnings: Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Checking for Understanding Victoria Corporation begins operations on March 1 by issuing 100, 000 common shares for cash at $12 per share. On March 15, it issues 5, 000 common shares to its lawyers in settlement of their bill for $65, 000. The shares continue to trade at $12 per share on march 15. On June 1, Victoria repurchased 10, 000 of it’s shares at $10 per share. Record the share transactions. (page 677) Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Preferred Shares and Dividends Priority over common shares for dividends and assets in the event of liquidation of the company. Generally do not have voting rights • Entries to record issue and reacquisition of preferred shares similar to entries for common shares • Transactions for each class of share is recorded in a separate account • Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Dividend Preference Preferred shareholders have a right to dividends before common shareholders • Cumulative preferred shares have a right to current year’s dividends and any prior years’ dividends owing before dividends are paid on common shares • Any unpaid dividends (in arrears) are not considered a liability • Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Dividend Preference Staudinger Corporation has 10, 000 $3 -cumulative preferred shares. The $3 is the per share dividend amount, which is usually expressed as an annual amount, similar to interest rates. So, Staudinger’s annual total dividend is $30, 000 (10, 000 * $3 per share)$90 Dividends in arrears ($30, 000 * 2) Current year dividends Total preferred dividends Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. $60, 000 $30, 000 $90, 000

Convertible Preferred Shares Provide option to exchange preferred shares to common shares at a specified ratio • Conversion is recorded by transferring cost from Preferred Shares to Common Shares account • Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Convertible Preferred Shares • Ross Industries Inc. issues 1, 000 convertible preferred shares at $100 per share. One preferred she is convertible into 10 common shares. The current market price of the common shares is $9 per share. If the market price of the convertible preferred shares is $101 and common shares is $12 on June 10. The convertible preferred shareholder will choose to convert their shares. Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Redeemable and Retractable Preferred Shares Corporation (redeemable) give the issuing corporation the right to purchase the shares at specified future dates and prices • shareholder (retractable) gives the shareholder the option to sell the shares back to the corporation at a future date and price • Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Redeemable and Retractable Preferred Shares Redeemable and retractable preferred shares are similar in some ways to debt. • Considered a financial instrument (contract between two or more parties that establishes financial rights or obligation) • Usually reported in the liabilities section of the balance sheet • Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Checking for understanding Turin Corporation issued 50, 000 preferred shares on February 22 for $20, 000 each. Each share was convertible into 10 common shares. ON April 12, another 30, 000 preferred shares were issued for $30 each. On June 5, when the price of the common share was $4 and the price of the preferred shares was $35, shareholder converted 20, 000 of the preferred share into common. Record the 3 transactions in a journal (page 681) Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Practice • • Self study questions: 3 -7 Questions 11+13+14 BE 13 -3 9 E 13 -4 6 Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Shareholders’ Equity on the Balance Sheet Contributed Capital • Share capital: preferred and common shares • Preferred shares are listed first • Additional contributed capital: amounts contributed from acquiring and retiring shares Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Agenda • Statement presentation and analysis • Presentation of shareholder’s equity • Analysis of the statement Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Shareholders’ Equity on the Balance Sheet • Retained Earnings • Cumulative net income (loss) since incorporation • Annual net income is added; dividends are deducted (similar to drawings by the owner in a proprietorship) Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Shareholders’ Equity on the Balance Sheet Closing journal entries Dec. 31 Service Revenue 500, 000 Income Summary 500, 000 To close revenue to income summary Dec. 31 Income Summary 290, 000 Operating expenses 290, 000 To close operating expenses to income summary Dec. 31 Income Summary 210, 000 Retained earnings To close income summary (500, 000 -290, 000) to retained earnings Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. 210, 000

Shareholders’ Equity on the Balance Sheet Dec. 31 Retained Earnings 80, 000 Dividends To close dividends to retained earnings. Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. 80, 000

Shareholders’ Equity on the Balance Sheet Accumulated Other Comprehensive Income • Certain gains and losses that bypass net income but affect shareholder’s equity. • Recorded directly to shareholders’ equity • Things like: • unrealized gain or loss on available for share securities. • Gain/loss of cash flow hedge • Gain/loss from foreign currency translation • Gain/loss on defined benefit pension plan Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Sample Shareholders’ Equity Section Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Return on Equity Also called return on investment • Considered to be the most important measure of a firm’s profitability • It evaluates how many dollars are earned for each dollar invested by shareholders • Net income ÷ Average Shareholders’ Equity = Return on Equity Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Check for understanding Look on page 684 -685 and the demonstration problem Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.

Practice Self study question 8 • BE 13 -10 13 • E 13 -7 11 • Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd.