Shareholders’ Equity

2. Shareholders’ Equity Chapter 14

3. The primary advantages are: limited liability capital accumulation ease of ownership transfer potential for an expanded equity base The Corporate Form of Organization Advantages and Disadvantages

4. The disadvantages include: increased taxation difficulties of control limited power of minority shareholders cost to operate The Corporate Form Of Organization Advantages and Disadvantages (cont.)

5. Federal and provincial legislation governs the formation and operation of corporations A corporation may be formed either provincially or federally About half of the 200 Canadian public companies surveyed by FinancialReporting in Canada 2000 are incorporated federally Private vs. Public Corporations

6. 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 that describes the way in which shares can be transferred Approximately 50% of the corporations on the Financial Post list of the 500 largest Canadian corporations are private Private vs. Public Corporations (cont.)

7. Public companies: companies whose securities, either debt or equity, are traded on stock exchanges Private placement:issuing financial instruments to a single buyer or a syndicate of buyers; not made available to the public; benefits include the ability to modify terms to address specific investor needs and to avoid requirements imposed by securities regulators (OSC, SEC, etc.) Private vs. Public Corporations (cont.)

8. 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 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 Share Capital

9. Preferred shares are so designated because they confer certain preferences, or differences, over common shares Preference may involve one of the following: voting rights dividends cumulative participating assets upon liquidation convertibility to other securities guarantee Share Capital (cont.)

10. 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 Premiums and discounts are recognized and recorded in separate equity accounts Par Value versus No-Par Value Shares

11. No-par shares do not carry a designated or assigned value per share The entire amount of proceeds received by the company is credited to share capital Par Value versus No-Par Value Shares(cont.)

12. Fundamental Share Equity Concepts and Distinctions • The fundamental concepts that underlie the accounting and reporting of shareholders’ equity may be summarized as follows: • separate legal entity • sources of shareholders' equity • cost-base accounting • no impact on income

13. Authorized share capital:the maximum number of shares that can be legally issued Issued share capital: the number of shares that have been issued to shareholders to date Unissued share capital: the number of shares of authorized share capital that have not been issued when there is a limit on the number of authorized shares, that is, the difference between authorized and issued shares Fundamental Share Equity Concepts and Distinctions (cont.)

14. Outstanding share capital: issued and currently owned by shareholders Treasury shares:outstanding shares reacquired Subscribed shares:unissued shares set aside to meet subscription contracts Fundamental Share Equity Concepts and Distinctions (cont.)

15. Exhibit 14-1

16. 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)

17. Accounting for Share Capital at Issuance (cont.) • 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

18. Accounting for Share Capital at Issuance (cont.) • 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

19. Accounting for Share Capital at Issuance (cont.) • 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 • (3) keep the moneys received.

20. Accounting for Share Capital at Issuance (cont.) • Non-Cash Sale of Share Capital: Corporations sometimes issue share capital for non-cash assets • When a corporation issues its shares for non-cash assets or services or to settle debt, the transaction should be recorded at the fair value–but there are two fair values present • the fair value of the asset received, and • the fair value of the shares issued

21. Accounting for Share Capital at Issuance (cont.)

22. Accounting for Share Capital at Issuance (cont.) • Basket Sales of Share Capital:a corporation sells two or more classes for one lump-sum amount (often referred to as a basket sale) • Two methods used in such situations are: • the proportional method, in which the lump sum received is allocated proportionately among the classes of shares on the basis of the relative market value of each security

23. Accounting For Share Capital At Issuance (cont.) • the incremental method, in which the market value of one security is used as a basis for that security and the remainder of the lump sum is allocated to the other class of security • when there is no market value for any of the issued securities, proceeds may be allocated arbitrarily

24. Accounting For Share Capital At Issuance (cont.) • Share Issue Costs:costs corporations incur when they issue shares in a public offering, e.g., registration fees, underwriter commissions, legal and accounting fees, printing costs, clerical costs, and promotional costs

25. Accounting For Share Capital At Issuance (cont.) • Two methods of accounting for share issue costs are found in practice: • offset method: share issue costs are treated as a reduction of the amount received from the sale of the related share capital • retained earnings method:share issue costs are charged directly to retained earnings in a variation of the offset method

26. 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 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 Retirement of Shares

27. A company may retire shares for the following reasons: to increase earnings per share 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 Retirement of Shares (cont.)

28. When shares are purchased and immediately retired, all capital items relating to the specific shares are removed from the accounts If cumulative preferred shares are retired, and there are dividends in arrears, such dividends are paid and charged to retained earnings in the normal manner Retirement of Shares (cont.)

29. Where the reacquisition cost of the acquired shares is different from the average original issuance price, the CICA Handbook recommends that the cost be allocated as follows for no-par shares: Reacquisition cost is higher than the average price per share issued to date, the cost should be charged in this sequence: to share capital at the average price per issued share to any contributed capital that was created by earlier treasury stock transactions in the same class of shares any remaining amount to retained earnings Retirement of Shares (cont.)

30. Retirement of Shares (cont.) • Reacquisition cost is lower than the average price per share issued to date, the cost should be charged: • to share capital at the average price per issued share • any remaining amount to contributed capital • The effect of these rules is to ensure that a corporation records no income effect (i.e., no gain or loss on the income statement) on buying back its own shares

31. A firm may also buy its own shares and hold them for eventual resale Such shares may not vote at shareholder meetings or receive dividends The Canada Business Corporations Act (and provincial legislation modelled after the act) provides that corporations that reacquire their own shares must immediately retire those shares Treasury Stock

32. Retained Earnings • Retained earnings represent accumulated net income or net loss (including all gains and losses), error corrections, and retroactive changes in accounting policy, if any, less accumulated cash dividends, property dividends, stock dividends, and other amounts transferred to contributed capital accounts

33. Retained Earnings (cont.) The following items affect retained earnings: • Decreases (debits): • net loss (including extraordinary items) • error correction (may also be a credit) • affect 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

34. 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) Retained Earnings (cont.)

35. 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 • The following are examples of some of the ways in which appropriations and restrictions may arise: • 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

36. Appropriations and Restrictions of Retained Earnings (cont.) • 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

37. Reporting Retained Earnings • The statement of retained earnings may include the following: • beginning balance of retained earnings • restatement of beginning balance for error corrections • restatement of beginning balance for retroactively applied accounting changes • net income or loss for the period

38. Reporting Retained Earnings (cont.) • dividends declared for the period • appropriations and restrictions of retained earnings (may alternatively be disclosed in the notes) • adjustments made pursuant to a financial reorganization • adjustments resulting from some share retirements • ending balance of retained earnings

39. Exhibit 14-2

40. Exhibit 14-2 (cont.)

41. 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

42. Relevant Dividend Dates • Date of Declaration: the date the corporation's board of directors formally announces the dividend declaration • Date of Record: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

43. Relevant Dividend Dates (cont.) • Ex-Dividend Date:the day following the date of record • Date of Payment:the actual day of the payment of the dividend • the date of payment typically follows the declaration date by four to six weeks

44. Legality of Dividends • The following two provisions must be present for dividends to be declared: • dividends may not be paid from legal capital (usually represented in the share capital accounts) without permission from creditors • retained earnings are available for dividends unless there is a contractual or statutory restriction

45. Legality of Dividends (cont.) • 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

46. Cumulative Dividend Preferences on Preferred Shares • 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

47. Cumulative Dividend Preferences on Preferred Shares(cont.) • 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

48. Participating Dividends • Participating preferred shares provide that the preferred shareholders participate above the stated preferential rate on a pro rata basis in dividend declarations with the common shareholders • first, preferred shareholders receive their preference rate • second, the common shareholders receive a specified matching dividend • then, if the total declared dividend is larger than these two amounts, the excess is divided on a pro rata basis between the two share classes

49. Property dividends or dividends in kind:payment of a dividend with non cash assets 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 board of directors A property dividend is recorded at the current market value of the assets transferred Property Dividends and Spin-Offs

50. Spin-off: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 Property Dividends and Spin-Offs (cont.)