15. Shareholders Equity

What are the three inherent rights of shares?

To share proportionately in profits and losses, in management through voting, and in corporate assets upon liquidation.

What is the pre-emptive right?

It allows existing shareholders to maintain their proportional ownership by buying new shares before others.

Why are shares easy to transfer?

Shares are personal property and can be sold at any time without company consent.

What are common shares?

They represent residual ownership, carry risks and rewards, provide voting rights, and offer benefits only if the company is profitable.

What are preferred shares?

Shares with preferential rights, such as priority claims on earnings or assets, often with limited voting rights.

Name a feature of preferred shares.

They may be cumulative, meaning unpaid dividends accumulate for future payment; They may be convertible into common shares at a predetermined ratio; They may be callable or redeemable by the issuing corporation at specified prices or dates.

Can share capital be withdrawn freely?

No, it cannot be withdrawn until all prior claims on corporate assets are satisfied.

What is par value?

A nominal amount per share establishing maximum shareholder responsibility in insolvency.

What restrictions exist on dividend payments?

Dividends cannot reduce corporate capital below liabilities, must be board-approved, and follow share agreements.

Why might companies limit dividends even if legally allowed?

To comply with bond covenants, retain funds for growth, smooth payments, and maintain a buffer against losses.

How do dividend policies differ between mature and growth companies?

Mature companies maintain stable dividends, while growth companies pay few or no dividends to reinvest for expansion.

Why is liquidity important before declaring dividends?

Cash must be available to meet operational needs and current liabilities.

How does inflation affect dividend decisions?

Inflation can understate replacement costs, making it risky to pay dividends without adjusting for future purchasing power.

What are the basic steps a company takes when issuing shares?

Shares are authorized, offered for sale with contracts, amounts due are collected, and then the shares are issued

How is the market price of shares determined?

Companies hire investment bankers or underwriters to value shares, promote them, and manage the sale.

How are underwriting fees treated in share issuance?

Fees paid to underwriters are deducted from total proceeds; the net amount received is credited to common or preferred shares.

How are receivables for unpaid shares typically presented?

Usually as a reduction of shareholders’ equity, unless collection is virtually guaranteed.

What happens when shares are sold on a subscription basis?

Only partial payment is collected initially; shares are issued when the full subscription price is received.

How are defaults on subscription payments handled?

Companies may refund payments, transfer amounts to Contributed Surplus, or issue fewer shares corresponding to payments received.

How are lump-sum share sales allocated between multiple share classes?

Using the relative fair value method or the residual value method.

How are direct and indirect costs of issuing shares treated?

Direct costs reduce share capital; indirect costs, like management salaries, are expensed

Why do companies buy back shares?

To increase EPS and ROE, provide for employee options, defend against takeovers, stabilize share price, return cash, go private, or manage regulatory capital.

What is a treasury share?

A share reacquired by the company that may be held for reissue, reducing shareholders’ equity.

How are gains or losses on repurchased shares recorded?

Through equity accounts (Share Capital, Contributed Surplus, Retained Earnings), not the income statement.

What are the two main classes of dividends?

Return on capital (from earnings) and return of capital (liquidating dividends)

How are property dividends measured?

At fair value of the asset given up, unless part of a liquidation or restructuring, then at carrying amount

How do stock dividends affect shareholders?

Additional shares are issued, proportional ownership remains the same, and book value per share decreases.

How are dividend preferences applied?

Allocation depends on whether preferred shares are cumulative, non-cumulative, participating, or non-participating; unpaid dividends may be carried over or included in current distribution.

What is a stock split and how is it recorded?

A stock split increases shares outstanding with no change in total share capital or retained earnings; only a memorandum note is made.

How is a large stock dividend treated?

If over 20–25% of shares outstanding, it is treated more like a stock split, sometimes recorded as a memo entry; otherwise, it is recorded like a regular dividend.

What are the four main categories of shareholders’ equity in a corporation?

Common and/or preferred shares, contributed surplus, retained earnings (or deficit), and accumulated other comprehensive income under IFRS.

Which components make up contributed capital and which make up earned capital?

Contributed capital consists of shares and contributed surplus, while earned capital consists of retained earnings and accumulated other comprehensive income.

What does a large retained earnings balance usually imply about a company?

That the company has been historically profitable on a cumulative basis.

What is the difference between contributed (paid-in) capital and earned capital?

Contributed capital is the amount shareholders provide to the company for use in the business, while earned capital comes from profits retained in the business.

How is accumulated other comprehensive income treated under IFRS compared to ASPE?

Under IFRS it is reported as part of equity, while under ASPE it does not exist and only a statement of retained earnings is provided.

What are the main sources of retained earnings?

Income from operations, which may include main business activities, secondary activities, and unusual items.

What is accumulated other comprehensive income?

The cumulative change in equity from revenues, expenses, gains, and losses excluded from net income, often unrealized but still considered earned income.

What are companies required to disclose regarding capital under IFRS?

Changes in all equity accounts, restrictions on retained earnings or dividends, sources of restrictions, amounts restricted or unrestricted, and information about objectives, policies, and processes for managing capital.

What is the rate of return on common shareholders’ equity and how is it calculated?

It measures profitability from the common shareholders’ perspective, calculated as net income less preferred dividends divided by average common shareholders’ equity.

What does it mean for a company to be “trading on the equity”?

It means using debt or preferred shares with fixed costs to achieve a higher return for common shareholders, as long as the return on assets exceeds the borrowing cost.

What is the payout ratio and how is it calculated

It measures dividend policy, calculated as cash dividends paid to common shareholders divided by net income available to common shareholders.

What is the price earnings ratio and what does it indicate?

It is the market price of a share divided by earnings per share, used to assess the investment potential of a company.

What is book value per share and how is it calculated?

It represents the equity value per common share based on reported amounts, calculated by dividing common shareholders’ equity by the number of common shares outstanding.

How does the presence of preferred shares affect book value per share?

Retained earnings may need to be allocated between preferred and common shareholders, especially if dividends are in arrears, shares are participating, or preferred shares have a higher redemption value.