shareholders’ equity: capital

McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

Shareholders’ Equity:Shareholders’ Equity:CapitalCapital

Chapter 11

11-2

Existence is separate from

owners.

Existence is separate from

owners.

An entity created by law.

An entity created by law.

Has rights and privileges.

Has rights and privileges.

Privately, or Closely Held

Publicly Held

Ownership can be

Ownership can be

CorporationsCorporations

11-3

Limited personal liability for

shareholders

Limited personal liability for

shareholders

Transferability of ownership

Transferability of ownership

Professional managementProfessional management

Continuity of existence

Continuity of existence

Advantages of Advantages of IncorporationIncorporation

11-4

Heavy taxationHeavy taxation

Greater regulationGreater regulation

Cost of formationCost of formation

Separation of ownership and management

Separation of ownership and management

Disadvantages of Disadvantages of IncorporationIncorporation

11-5

The costs associated with

incorporation are usually expensed

immediately.

The costs associated with

incorporation are usually expensed

immediately.

Formation of a CorporationFormation of a Corporation

• Each corporation is formed according to the laws of the place or country where it is located.

• The application for corporate status is supported by the Memorandum and Articles of Incorporation.

11-6

Shareholders

Rights

Voting (in person or by proxy).

Proportionate distribution of

dividends.

Proportionate distribution of

assets in a liquidation.

Rights of ShareholdersRights of Shareholders

11-7

C orpora te O rgan iza tion C hart

Secretary Treasurer C ontro ller O ther V icePresidents

President

B oard of D irectors

ShareholdersUltimate control

Ultimate control

Rights of ShareholdersRights of Shareholders

Shareholders usually meet once a year.

Shareholders usually meet once a year.

11-8

C orpora te O rgan iza tion C hart

Secretary Treasurer C ontro ller O ther V icePresidents

President

B oard of D irectors

Shareholders

Chief Accountant

Chief Accountant

Contractual and legal representation

Contractual and legal representation

Custodian of funds

Custodian of funds

Functions of the Corporate Functions of the Corporate OfficersOfficers

11-9

Publicly Owned Corporations Publicly Owned Corporations Face Different RulesFace Different Rules

By law, publicly owned corporations must:Prepare financial statements in accordance with relevant accounting standards, e.g. IFRS.Have their financial statement audited by an independent CPA.Comply with relevant rules and regulations.Submit financial information for relevant authority for review.

11-10

Shareholders usually meet once a year.Shareholders usually meet once a year.

Shareholder ledgers are often maintained by a share transfer agent or share registrar.

Shareholder ledgers are often maintained by a share transfer agent or share registrar.

Shareholder Records in a Shareholder Records in a CorporationCorporation

Each unit of ownership is called a share.

Share certificates serve as proof that a shareholder has purchased shares.

Each unit of ownership is called a share.

Share certificates serve as proof that a shareholder has purchased shares.

When the share is sold, the shareholder signs a transfer endorsement on the back of the share

certificate.

When the share is sold, the shareholder signs a transfer endorsement on the back of the share

certificate.

11-11

Paid Capital

Contributions byinvestors in exchange

for share.

Retained Earnings

Retention of profitsearned by thecorporation.

Shareholders' equity isincreased in tw o w ays.

Shareholders’ Equity of a Shareholders’ Equity of a CorporationCorporation

11-12

The maximum number of

shares that can be sold to the

public.

AuthorizedShares

AuthorizedShares

Authorization and IssuanceAuthorization and Issuanceof Share Capital of Share Capital

11-13

Issued shares are authorized shares that have been

sold.

Unissued shares are authorized shares that never have been sold.

Usually shares are

sold through an

underwriter.

Usually shares are

sold through an

underwriter.

AuthorizedShares

AuthorizedShares

Authorization and IssuanceAuthorization and Issuanceof Share Capital of Share Capital

11-14

UnissuedShares

UnissuedShares

TreasuryShares

OutstandingShares

Treasury shares are issued shares that

have been reacquired by the corporation.

Treasury shares are issued shares that

have been reacquired by the corporation.

IssuedSharesIssuedShares

Outstanding shares are issued shares that are

owned by shareholders.

Outstanding shares are issued shares that are

owned by shareholders.

AuthorizedShares

AuthorizedShares

Authorization and IssuanceAuthorization and Issuanceof Share Capitalof Share Capital

11-15

• Par value is an arbitrary amount assigned to each share when it is authorized.

• Market price is the amount that each share will sell for in the market.

• Par value is an arbitrary amount assigned to each share when it is authorized.

• Market price is the amount that each share will sell for in the market.

Shareholders’ EquityShareholders’ Equity

11-16

Ordinary share can be issued in three forms:Ordinary share can be issued in three forms:

No-Par Ordinary

Share

No-Par Ordinary

Share

Par Value Ordinary

Share

Par Value Ordinary

Share

Stated Value Ordinary

Share

Stated Value Ordinary

Share

All proceeds credited to

Ordinary Share Capital

All proceeds credited to

Ordinary Share Capital

Treated like par value ordinary

share

Treated like par value ordinary

share

Shareholders’ EquityShareholders’ Equity

Let’s examine this form of share.

Let’s examine this form of share.

11-17

Assume a corporation issues 10,000 shares of its $2 par value share for $25 per share.


Record:

1.The cash received.

2.The number of shares issued × the par value per share in the Ordinary Share account.

3.The remainder is assigned to Share Premium (or Additional Paid-in Capital).

Record:

1.The cash received.

2.The number of shares issued × the par value per share in the Ordinary Share account.

3.The remainder is assigned to Share Premium (or Additional Paid-in Capital).

Issuance of Par Value ShareIssuance of Par Value Share

11-18




Description Debit Credit

Cash 250,000 Ordinary Share 20,000 Share Premium 230,000

10,000 × $2 = $20,00010,000 × $2 = $20,000

11-19


Shareholders' Equity with Ordinary ShareShareholders' Equity

Contributed capital:

Ordinary share - $2 par value; 50,000 shares

authorized; 10,000 shares issued and

outstanding $ 20,000

Share premium 230,000

Retained earnings 65,000

Total shareholders' equity $ 315,000

11-20

Preference SharePreference ShareA separate class of share, typically having

priority over ordinary shares in . . . Dividend distributions (rate is usually

stated). Distribution of assets in case of liquidation. Specific characteristics (say redeemable)

can affect its presentation in the balance sheet as liabilities (IAS 32).

Cumulative dividend rights.

Cumulative dividend rights.

Normally has no voting

rights.

Normally has no voting

rights.

Usually callable by

the company.

Usually callable by

the company.

Other Features Include:

11-21

Vs. NoncumulativeCumulative

Dividends in arrears must be

paid before dividends may be paid on ordinary

share.

Dividends in arrears must be

paid before dividends may be paid on ordinary

share.

Undeclared dividends from

current and prior years do not have to be paid in future

years.

Undeclared dividends from

current and prior years do not have to be paid in future

years.

Cumulative Preference Cumulative Preference Share Share

11-22

Example: Consider the following partial Statement of Shareholders’ Equity.

During 2008, the directors declare cash dividends of $5,000. In 2009, the directors

declare cash dividends of $42,000.

Share Preferred as to Share Preferred as to DividendsDividends

11-23

Share Preferred as to Share Preferred as to DividendsDividends

Preferred CommonIf Preferred Stock is Noncumulative:Year 2008 $5,000 dividends declared 5,000$ -$

Year 2009 Step 1: Current preferred dividend 9,000$

Step 2: Remainder to common shareholders 33,000$

If Preferred Stock is Cumulative:Year 2008 $5,000 dividends declared 5,000$ -$

Year 2009 Step 1: Dividends in arrears 4,000$ Step 2: Current preferred dividend 9,000 Step 3: Remainder to common shareholders 29,000$

Totals 13,000$ 29,000$

Preferred CommonIf Preference Share is Noncumulative:Year 2008 $5,000 dividends declared 5,000$ -$

Year 2009 Step 1: Current preference dividend 9,000$

Step 2: Remainder to ordinary shareholders 33,000$

If Preference Share is Cumulative:Year 2008 $5,000 dividends declared 5,000$ -$

Year 2009 Step 1: Dividends in arrears 4,000$ Step 2: Current preference dividend 9,000 Step 3: Remainder to ordinary shareholders 29,000$

Totals 13,000$ 29,000$

11-24

I just converted 100 shares of preference share into

1,000 ordinary shares and ended up with a higher

dividend yield!

I just converted 100 shares of preference share into

1,000 ordinary shares and ended up with a higher

dividend yield!

Some preference share is

convertible into ordinary shares.

Other Features of Other Features of Preference SharePreference Share

11-25

Preference SharePreference ShareShareholders' Equity with Ordinary and Preference ShareShareholders' Equity Contributed Capital: Preference Share - $100 par value; 1,000 shares authorized; 50 shares issued and outstanding 5,000$ Ordinary Shares - $10 par value; 50,000 shares authorized; 30,000 shares issued and outstanding 300,000 Share Premium 1,000 Retained Earnings 65,000 Total Shareholders' Equity 371,000$

11-26

Accounting by the issuer.

Accounting by the issuer.

Accounting by the investor.

Accounting by the investor.

Ordinary share is carried at original issue

price.

Ordinary share is carried at original issue

price.

Investments in marketable securities are carried at market

value.

Investments in marketable securities are carried at market

value.

Market ValueMarket Value

11-27

Market Price of Preference Market Price of Preference ShareShare Factors affecting market price of Factors affecting market price of

preference share:preference share:• Dividend rateDividend rate• RiskRisk• Level of interest ratesLevel of interest rates

The return based on the market value is called the

“dividend yield.”

The return based on the market value is called the

“dividend yield.”

11-28

Factors affecting market price of ordinary share:

Investors’ expectations of future profitability.

Risk that this level of profitability will not be achieved.

Factors affecting market price of ordinary share:

Investors’ expectations of future profitability.

Risk that this level of profitability will not be achieved.

Changes in market value

have no impact on the books of the issuer.

Changes in market value

have no impact on the books of the issuer.

Market Price of Ordinary Market Price of Ordinary ShareShare

11-29

Book Value per ShareBook Value per Shareof Ordinary Shareof Ordinary Share

Total Shareholders’ EquityNumber of Ordinary Shares Outstanding

Preference share and preferencedividends in arrears are deducted

from total shareholders’ equity.

Book Value Market Value≠

11-30

Ice Cream Parlor

Share SplitsNow

Available

Share SplitsShare Splits

Companies use share splits to reduce market price.

Outstanding shares increase, but par value is decreased proportionately.

Companies use share splits to reduce market price.

Outstanding shares increase, but par value is decreased proportionately.

11-31

Assume a corporation has 5,000 shares of $1 par value ordinary share

outstanding before a 2–for–1 share split.

Increase

Decrease

No Change

Share SplitShare Split

Before Split After Split

Ordinary Shares 5,000 10,000

Par Value per Share 1.00$ 0.50$

Total Par Value 5,000$ 5,000$

11-32

When share is reacquired, the corporation records the treasury share at cost.

When share is reacquired, the corporation records the treasury share at cost.

Treasury shares are

issued shares that have been reacquired

by the corporation.

Treasury shares are

issued shares that have been reacquired

by the corporation.

Treasury ShareTreasury Share

11-33


Treasury Stock 165,000 Cash 165,000 3,000 shares × $55 = $165,000

Riley Corporation reacquires 3,000 shares of its ordinary share at $55 per share.Prepare the journal entry to record the

purchase of treasury share.

Recording Purchases of Recording Purchases of Treasury ShareTreasury Share


Treasury Share 165,000 Cash 165,000 3,000 shares × $55 = $165,000

11-34

Riley Corporation reissued 1,000 shares of the treasury share originally purchased for $55 per share. The shares were reissued at

$75 per share.

Recording Purchases of Recording Purchases of Treasury ShareTreasury Share


Cash 75,000 Treasury Share 55,000 Share Premium: Treasury Share 20,000

1,000 shares × $55 cost = $55,0001,000 shares × $55 cost = $55,000

1,000 shares × $75 = $75,0001,000 shares × $75 = $75,000

11-35

Shareholders’ Equity Shareholders’ Equity PresentationPresentation

Shareholders' Equity Contributed capital: Preference Share - $100 par value; 1,000 shares authorized; 50 shares issued & outstanding 5,000$ Ordinary Share - $10 par value; 50,000 shares authorized; 30,000 shares issued and outstanding 300,000 Share Premium 21,000 Retained earnings 65,000 Subtotal 391,000$ Less: Treasury share 110,000 Total Shareholders' equity 281,000$

11-36

Share Buyback ProgramsShare Buyback Programs

Some corporations have buyback programs, in which they repurchase large amounts of their own ordinary share. As a result of these programs, treasury share has become a material item in the balance sheet of many corporations.

Share option plans are an important part of employee compensation for many companies. Treasury share purchases are an effective means by which the company can have available the shares needed to satisfy the requirement of share option plans to issue the shares to employees.

Some corporations have buyback programs, in which they repurchase large amounts of their own ordinary share. As a result of these programs, treasury share has become a material item in the balance sheet of many corporations.

Share option plans are an important part of employee compensation for many companies. Treasury share purchases are an effective means by which the company can have available the shares needed to satisfy the requirement of share option plans to issue the shares to employees.

11-37

Financial Analysis andFinancial Analysis andDecision MakingDecision Making

Return on OrdinaryShareholders’ Equity

Profit – Preference DividendsAverage Ordinary Shareholders’ Equity

=

11-38

End of Chapter 11End of Chapter 11

shareholders’ equity: capital

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