Accounting- Chapter 11 Shareholder’s Equity

Who owns shares of a company?

Individuals, companies, pension funds, or institutional investors.

What are the main components of shareholders' equity?

• Share Capital – money from issuing shares

• Retained Earnings – profits kept, not paid as dividends

• Accumulated Other Comprehensive Income (AOCI) – unrealized gains/losses

• Contributed Surplus – extra from share transactions or stock options

What is retained earnings?

Portion of net income not paid as dividends; reinvested in the company.

What is AOCI?

• Accumulated unrealized gains/losses not from transactions with third parties

• affects total comprehensive income but not retained earnings

What is contributed surplus?

Amount from share sales above:

• par value

• stock option issuance

• treasury share transactions

What are the classifications of shares?

• Authorized: Maximum allowed to issue.

• Issued: Shares sold to shareholders.

• Outstanding: Shares held by shareholders.

• Treasury: Repurchased, not canceled; no voting or dividend rights.

What are preferred shares?

• Shares with priority for dividends and liquidation.

• Typically non-voting

• hybrid security (debt-like fixed dividends, equity-like ownership).

List types of preferred shares.

• Perpetual: Fixed dividend indefinitely.

• Floating Rate: Linked to benchmarks.

• Rate Reset: Dividend fixed until reset.

• Redeemable: Company can repurchase.

• Retractable: Shareholder can request repurchase.

• Convertible: Converts to common shares.

• Cumulative: Unpaid dividends accumulate.

• Participating: Shares excess dividends with common shareholders.

Why do companies issue multiple share types or classes?

• To attract diverse investors

• manage risk

• maintain control

• raise capital flexibly

• Can also provide different voting rights (e.g., Class A vs. Class B shares).

What are the requirements for a company to declare dividends?

Sufficient retained earnings and cash; board of directors must declare the dividend.

What are the two most common types of dividends?

• Cash Dividend: Paid in cash; reduces retained earnings and assets.

• Stock Dividend: Paid in shares; reduces retained earnings, increases share capital, total equity unchanged.

What are the key dates in dividend declaration?

• Date of Declaration: Liability created.

• Ex-Dividend Date: Determines eligible shareholders.

• Date of Record: Identifies entitled shareholders.

• Date of Payment: Liability settled; dividends paid.

What is a special dividend?

One-time distribution outside normal cycle, often due to exceptional earnings or cash reserves.

What is a stock split?

• Issues additional shares at a ratio (e.g., 2-for-1)

• without affecting retained earnings

• reduces market price per share

What is a reverse stock split?

• Reduces number of shares (e.g., 1-for-2)

• increases price per share

• often to meet stock exchange minimums or attract investors

How are stock splits accounted for?

Memorandum entry; no journal entry.

What is the Price/Earnings (P/E) ratio?

P/E = Market Price per Share ÷ EPS; indicates how the market values earnings.

What is the Dividend Payout Ratio?

Dividend Payout = Dividends per Share ÷ EPS; shows how much earnings is paid as dividends.

What is Dividend Yield?

• Dividend Yield = Dividends per Share ÷ Market Price per Share

• measures dividend return relative to share price

What is Return on Equity (ROE)?

ROE = Net Income ÷ Average Common Shareholders’ Equity; shows profitability relative to shareholder investment.

What are the advantages of equity financing?

• No repayment

• dividends optional

• permanent capital

• strengthens balance sheet

• signals growth opportunities

What are the disadvantages of equity financing?

Dilution of ownership, dividends not tax-deductible.

How do you record issuance of shares for cash?

Dr. Cash, Cr. Common Shares (or Preferred Shares), Cr. Contributed Surplus (if above par value)

How do you record issuance of shares for non-cash assets?

Dr. Asset (Equipment, Inventory), Cr. Common Shares (or Preferred Shares), Cr. Contributed Surplus (if above par value)

How do you record repurchase of shares (treasury shares)?

Dr. Treasury Shares, Cr. Cash

How do you record declaration of a cash dividend?

Dr. Retained Earnings, Cr. Dividends Payable

How do you record payment of a cash dividend?

Dr. Dividends Payable, Cr. Cash

How do you record a stock dividend declaration?

Dr. Retained Earnings, Cr. Stock Dividends Distributable

How do you record distribution of a stock dividend?

Dr. Stock Dividends Distributable, Cr. Common Shares

Why might a company repurchase its own shares?

• Fulfill future share issuance (e.g., stock options)

• support/increase market price

• prevent hostile takeover

How are dividends on cumulative preferred shares treated if unpaid in prior years?

• Unpaid dividends accumulate (“dividends in arrears”)

• Must be paid before common shareholders

• Prior unpaid + current dividend before paying common

What key information is included in the shareholders’ equity section of the balance sheet?

• Share structure: authorized, issued, outstanding, par, rights/preferences/restrictions

• Equity accounts: contributed surplus, retained earnings, AOCI (IFRS only)

• Other: treasury shares, stock options, stock-based comp, restrictions

What is the effect of a stock split?

• Increases number of shares

• no effect on retained earnings or total equity

• reduces market price per share

• recorded as memorandum entry

What is the effect of a stock dividend?

Increases shares, reduces retained earnings, increases share capital, total equity unchanged

Difference between stock split and stock dividend?

Stock Split: Adjusts share count and market price; no effect on retained earnings. Stock Dividend: Increases shares, reduces retained earnings.

What is a memorandum entry in accounting?

Notation for recording changes without affecting account balances (e.g., stock splits)

What is a reverse takeover?

• Company issues shares to external investors

• External investors gain control, often to avoid a hostile takeover

• Original shareholders may still hold significant ownership

Average Common Shareholders’ Equity Formula?

Average Equity = (Opening Equity + Ending Equity) ÷ 2

What are the four main rights of common shareholders?

• Voting – at shareholder meetings

• Dividends – receive if declared

• Residual claim – share in assets if company liquidates

• Preemptive rights – participate in new share issues / avoid dilution

Why might a company perform a reverse stock split?

To increase share price, often for compliance with stock exchange requirements or to attract institutional investors

Why do companies issue stock dividends instead of cash dividends?

To preserve cash for growth or operations, while still distributing profits to shareholders

What is a cumulative preferred share?

A preferred share where unpaid dividends accumulate until declared

What is a participating preferred share?

A preferred share that allows shareholders to receive excess dividends with common shareholders

Authorized shares

Max number of shares a company is allowed to issue

Issued shares

Shares that have been sold to shareholders

Outstanding shares

Shares currently held by shareholders

Treasury shares

Repurchased shares not canceled; no voting or dividend rights

Perpetual

Fixed dividend indefinitely

Floating Rate

Dividend linked to benchmarks

Rate Reset

Dividend fixed until reset date

Redeemable

Company can repurchase the shares

Retractable

Shareholder can request repurchase

Convertible

Can be converted into common shares

Cumulative

Unpaid dividends accumulate until paid

Participating

Shares in excess dividends with common shareholders

Date of Declaration

Liability created; board approves dividend

Ex-Dividend Date

Determines which shareholders are eligible to receive the dividend

Date of Record

Identifies shareholders entitled to the dividend

Date of Payment

Liability settled; dividends are actually paid

Cash Dividend

Paid in cash; reduces retained earnings and assets

Stock Dividend

Paid in shares; reduces retained earnings, increases share capital, total equity unchanged

What is Earnings Per Share (EPS)?

EPS = (Net Income − Preferred Dividends) ÷ Average Common Shares

Why are preferred dividends subtracted in EPS?

Because EPS measures earnings available to common shareholders only

Which step comes first when calculating the P/E ratio?

Calculate EPS first, then divide market price by EPS

What is the date of record?

The date used to determine which shareholders receive the dividend

What is the ex-dividend date?

The cutoff date to buy shares and still receive the dividend

What happens if you buy shares on or after the ex-dividend date?

You do NOT receive the dividend

How are treasury shares recorded when repurchased?

Dr. Treasury Shares, Cr. Cash

How are gains or losses on treasury shares treated?

They are recorded in contributed surplus (NOT income)

What happens if shares are repurchased below cost?

The difference increases contributed surplus

What is market capitalization?

Market Cap = Share Price × Outstanding Shares

What does market capitalization represent?

The total market value of a company

What is the order of payment during liquidation?

Creditors → Preferred Shareholders → Common Shareholders

What is the most important accounting detail in the articles of incorporation?

The share structure (types and classes of shares)

Are dividends paid on treasury shares?

No — treasury shares do not receive dividends

What is a share buyback?

A repurchase of shares by the company (same as treasury shares)

Do issued shares always equal outstanding shares?

No — issued ≠ outstanding if treasury shares exist

Are dividends automatically paid every year?

No — dividends must be declared by the board of directors

How are preferred dividends typically structured?

They are usually fixed (set amount or percentage)