CSC Chapter 11: Corporations and their Financial Statements

What is a corporation?

A corporation is a distinct legal entity separate from the people who own its shares. An incorporated business pays taxes and can sue or be sued in a court of law. Property acquired by the corporation does not belong to the shareholders of the corporation, but to the corporation itself. The shareholders have no liability for the debts of the corporation, and there can be no additional levy on shareholders if the debts of a bankrupt corporation exceed the value of its realizable assets.

What is a sole proprietorship?

In a sole proprietorship, one person runs the business and is taxed on earnings at his or her personal income tax rate. The owner profits if the venture is successful, but is also personally liable for all debts, losses, and obligations arising from business activities. In other words, there is no distinction between personal assets and assets held in the business.

What is a partnership?

In a partnership, two or more persons run the business, the structure of which is legislated under the Partnership Act. Partnerships can be general or limited. With a general partnership, both (or all) general partners run the day-to-day operations and are personally liable for all debts and obligations incurred in the course of business. With a limited partnership, general partners run the business while limited partners cannot participate in daily business activities. The limited partners' liability is limited to the amount of their investments.

What are 6 advantages of incorporation?

Limited shareholder liability

Continuity of existence

Transfer of ownership

Ability to finance

Growth

Professional management

What is limited shareholder liability?

The shareholders of a corporation risk only the amount of money they have invested in the corporation's common shares. For example, a shareholder who has invested $1,000 in a corporation's common shares is not liable for additional contributions, even if the corporation were to go bankrupt and have obligations to creditors that exceed the value of its realizable assets.

What is continuity of existence?

A corporation's continued existence is not affected by the death of any or all of its shareholders. Its existence is terminated only by imposed acts such as bankruptcy of the corporation itself. A corporation is unlike a sole proprietorship, which ends when the proprietor dies. It also differs from a partnership, which terminates upon the death or withdrawal of one partner, unless an agreement to the contrary exists.

What is transfer of ownership?

Shareholders of a public corporation can usually transfer their shares to other investors with relative ease. This liquidity is an attractive feature of share ownership. And, although the ownership of shares may change, the assets of the corporation continue to be owned by the corporate entity itself.

What is ability to finance

Raising capital by issuing different classes of shares and debt instruments is much easier for corporations than for sole proprietorships or partnerships. Limited liability means that investors can contribute capital with a chance of return and without risk beyond the amount of the investment.

What is growth?

Corporations are structured to easily handle the large amounts of capital needed to operate large and growing businesses.

What is professional management?

The shareholders are the ultimate owners of the corporation, but they play a very small part in its management. Through their voting rights, they elect a board of directors to manage corporate affairs. If the directors do not manage the corporation to their satisfaction, the shareholders may elect different directors.

What are 4 disadvantages of incorporation?

Inflexibility

Taxation

Expense

Capital withdrawal

What is Inflexibility?

A corporation is subject to many rules imposed by various statutes. Changes in the charter and by-laws of the corporation can be complicated and sometimes require formal approval of the government of the incorporating jurisdiction, as well as of the directors and shareholders.

What is taxation?

The possibility of double taxation arises when the after-tax profits of a corporation are distributed in the form of dividends to shareholders, who themselves pay tax on their dividend income.

What is expense?

After the initial cost of incorporation, annual costs apply that are additional to those incurred in proprietorships or partnerships. Some of those costs include annual returns, audits, preparation of federal and provincial corporate tax returns, the holding of shareholders' meetings, and, for many corporations, securities laws.

What is Capital withdrawal?

Corporations must carefully follow statutory procedures for the purchase and redemption of shares by the corporation, when permitted by the applicable statute. However, relatively minor investors in a public corporation can withdraw their capital simply by selling their shares on the market.

What are private corporations?

Private corporations have charters that restrict the right of shareholders to transfer shares, limit the number of shareholders to no more than 50, and prohibit members from inviting the public to subscribe for their securities.

What are public corporations?

Public corporations are companies whose shares are listed on a stock exchange or traded over the counter.

What are some by-laws usually deal with the types of issues in a corporate.

• Shareholders' and directors' meetings

• Qualification, election, and removal of directors

• Appointment, duties, and remuneration of officers

• Declaration and payment of dividends

• Date of fiscal year end

• Signing authority for documents

What does common shareholders have?

The common shareholders of a publicly traded company have certain rights based on their equity investment in the company. . A very important right is the opportunity to vote on certain company matters at annual meetings and at special or general meetings.

Who does these shareholder vote?

Shareholders can vote in the election of the board of directors, who guide and control the business operations of the corporation through its officers. Shareholders can also vote on corporate matters such as the sale, merger, or liquidation of the business, as well as decision regarding a stock split or the amendment of the corporation's charter. Shareholders may also have the right to vote on executive compensation packages.

What is a shareholder meeting?

The list of eligible shareholders is prepared, and is effective, as of a certain date prior to a regular or annual shareholder meeting. Shareholders are then notified of the meeting within a specified time period. At the annual meeting, they elect the directors, appoint independent auditors (or accountants), receive the financial statements and the auditor's (or accountant's) report for the preceding year, and consider other matters regarding the company's affairs. To vote at the annual meeting, shareholders must have shares registered in their own name, or else they must be in possession of a completed proxy form.

What happens before the meeting?

Corporations see the annual shareholders' meeting as an opportunity to report on their activities to their shareholders. Before the meetings, shareholders receive a proxy statement that outlines what is to be voted on at the meeting.

Who are allow to vote?

Every shareholder who is registered on a company's books as owning shares is entitled to vote at the company's annual general meeting.

How do most shareholders vote?

Most retail investors cast their votes by proxy. The proxy is typically a member of the company's management team who is given authority through power of attorney to vote according to the shareholder's intentions. The shareholder indicates those intentions on a proxy statement (or proxy form).

What does the proxy statement need to have?

The proxy statement must accompany the notice of a shareholders' meeting, along with an information circular informing the shareholder of issues for consideration at the annual meeting. Such issues include details about proposed directors, directors' and officers' remuneration, interest of directors and officers in material transactions, the appointment of auditors, and particulars of other matters to be acted upon at the meeting. The proxy statement must be completed in writing and signed by the shareholder granting the proxy. If a shareholder does not vote or leaves the items on the proxy statement unmarked, the ballot is automatically cast with management's viewpoint. Therefore, it is important for shareholders to read the resolutions carefully and make their intentions clear.

What happens when a corporation is going through financial difficulty?

A corporation that is undergoing a restructuring because of financial difficulties may be placed under the control of a few individuals through a voting trust.

How long does this process go for?

The voting trust is usually put into effect for specific periods, or until certain results have been achieved. This measure is used because financiers may be willing to inject new capital only if they can be assured of control to protect their investment until the corporation recovers.

What happens when corporation goes through financial difficulties?

A corporation that is undergoing a restructuring because of financial difficulties may be placed under the control of a few individuals through a voting trust.

Why is voting trust used?

This measure is used because financiers may be willing to inject new capital only if they can be assured of control to protect their investment until the corporation recovers.

What are the top members at the top of the corporate structure?

Directors

Chairman of the board

President

Vice-Presidents

Officers

What is the responsibility of directors?

• Directors must be of the age of majority and of sound mind. A director must not be an undischarged bankrupt person.

• They set company policies by passing resolutions.

• They normally appoint and supervise officers and signing authorities for banking, budget approval, financing, and plans for expansion.

• They are normally responsible for the decision to issue shares and declare dividends and other dispositions of profits.

• They are personally liable for illegal acts of the corporation done with their knowledge and consent.

• They are personally responsible for employee wages, declared dividends, and government remittances.

• They must act honestly, in good faith, and in the best interests of the corporation.

What is the responsibility of chairman of the board?

• The chairman of the board is elected by the board of directors.

• Persons in this position may have all or any of the duties of the president or any other officer of the corporation.

• They may be the chief executive officer.

• They preside over meetings of the board and generally exert great influence on the management of the affairs of the corporation.

• Their job may be combined with that of president.

What is the responsibility of president?

• The president is appointed by and responsible to the board of directors.

• Persons in this position exercise authority through the other officers and through the heads of departments or divisions.

• If the job of president is not combined with that of the chairman, the president may act as chairman in the latter's absence.

What is the responsibility of vice-presidents?

• Vice-presidents are appointed by, and responsible to, the president.

• They lead specific areas of the corporation's operations, such as sales or finance.

What is the responsibility of officers?

• Officers are appointed by the board of directors.

• They are corporate employees responsible for the day-to-day operation of the business.

What is the international financial reporting standards?

In 2011, Canada adopted the International Financial Reporting Standards (IFRS), a globally accepted high-quality accounting standard used by public companies in more than 100 countries.

What does principle based accounting have?

Principles-based accounting has more general guidelines and broader objectives. For example, IFRS requires corporations to provide extensive and detailed disclosure to explain why particular accounting treatments are used, and enough data to allow an investor to make an objective analysis

What is the statement of financial position?

he statement of financial position shows a company's financial position on a specific date. In annual reports, that date is the last day of the company's fiscal year. Many companies have a fiscal year end that corresponds with the calendar year end (December 31), but this is not a requirement. Banks and trust companies traditionally end their fiscal year on October 31.

What are the three items shown in financial statement?

The statement of financial position shows three items:

• Assets consist of what the company owns and what is owed to it.

• Equity represents the shareholders' interest in the company.

• Liabilities are what the company owes.

What is the book value?

Equity is also referred to as the book value of the company. It represents the excess of the company's assets over its liabilities. Accordingly, the company's total assets are equal to the sum of equity plus the company's liabilities.

What does property, plant, and equipment (PP&E)

Noncurrent assets include property, plant, and equipment (PP&E); goodwill and other intangible assets; and investments in associates.

What does PP&E consist of

The category of PP&E consists of land, buildings, machinery, tools and equipment of all kinds, trucks, furnishings, and other items used in the day-to-day operations of a business. A company's PP&E is valuable because it is used directly in producing the goods and services the company eventually sells.

What is the current assets?

Current assets, which are consumed or converted by successive steps into cash, the items that make up a company's PP&E are not intended to be sold.

What is depreciation?

Property (except land), plant, and equipment wear out over time or otherwise lose their usefulness. Between the time that a given asset is acquired and the time when it is no longer economically useful, it decreases in value.

What are the two common way to calculate depreciation?

• The straight line method applies an equal amount to each period. This is the method used most frequently in Canada by public companies.

• The declining balance method applies a fixed percentage, rather than a fixed dollar amount, to the outstanding balance to determine the expense to be charged in each period. This amount is then deducted from the capital asset balance to determine the amount against which the percentage will be applied in the subsequent period (thus the term declining balance). The declining balance method typically uses some multiple of the straight line rate.

Where is cash reported?

These effects are reflected in the statement of cash flows, where the cash from operations is reported.

What are capitalizations recorded

Accounting activity called capitalization records an expenditure as an asset, rather than an expense.

What is good will?

Goodwill is often defined as the probability that a regular customer of a company will continue to do business with that company because of its location or its reputation for fair dealing and good products.

What is intangible assets?

Intangible assets are non-monetary assets that do not have physical substance. They can be sold, licensed, or transferred, but they usually decline greatly in value when a company is liquidated. Some common examples are patents, copyrights, franchises, and trademarks.

What is inventory?

Inventory consists of the goods and supplies that a company keeps in stock. For example, a furniture manufacturer that sells chairs to Trans-Canada Retail would have inventories of raw materials (the fabric and wood used to build the chairs), work-in-progress (the assembled chair frames), and finished goods (the completed chairs ready for shipping).

How are the two method that a commonly used?

• The weighted average method uses the average of the total cost of the goods purchased over the period on a per unit basis.

• The first-in-first-out (FIFO) method implies that items acquired earliest are assumed to be used or sold first.

What are prepaid expenses?

Prepaid expenses are payments made by the company for services to be received in the near future. Prepaid expenses are the equivalent of cash because they eliminate the need to pay cash for goods or services in the immediate future.

What is a trade receivable?

The trade receivables category represents money owing to a company for goods or services it has sold. Because some customers fail to pay their bills, an item called allowance for doubtful accounts is often subtracted from receivables.

What is cash and cash equivalent?

The cash and cash equivalents category represents cash on hand, funds in the company's bank accounts, or funds held in short-term investments.

What is share capital?

Share capital is the money paid in by shareholders. This is the amount received by the company for its shares at the time that they were issued.

What is retained earning?

Retained earnings represent the profits earned over time that have not been paid out as dividends—in other words, the portion of annual earnings retained by the company after payment of all expenses and the distribution of all dividends. The earnings retained each year are reinvested in the business.

What is non-controlling interest?

Non-controlling interest appears as a category when a company owns more than 50% of a subsidiary company and consolidates its financial statements.

What is classified as non-liabilities?

The long-term debt of a company is debt that is due in annual instalments over a period of years, or else in a lump sum in a future year. The most common of these debts are mortgages, bonds, and debentures.

What is a deferred tax liability?

The deferred tax liabilities category represents income tax payable in future periods. These liabilities commonly result from temporary differences between the book value of assets and liabilities as reported on the statement of financial position and the amount attributed to that asset or liability for income tax purposes

What are the four common type of current liability shown by trans-Canada retail statement of financial position

• Where earnings come from

• Where earnings go

• The adequacy of earnings, both to assure the successful operation of the company and to provide income for the holders of its securities

What are 2 of the following that are use to disclose the expense?

• By nature of their use (e.g., depreciation, raw materials, and employee benefits)

• By function (e.g., cost of sales, administrative, and distribution)

What is other income?

Other income is not directly related to a company's normal operating activities. This category includes dividends and interest from investments, rents, and sometimes profits from the sale of PP&E.

After adding others in to gross profit, what other following general are deduced?

• Distribution costs, including such expenses as advertising costs and salaries and commissions to sales personnel

• Administrative expenses, including office salaries, accounting staff salaries, and office supplies

• Other expenses not directly related to the company's normal operating activities, including expenses associated with the sale of PP&E

• Finance costs in the form of interest payments on debtholders' securities or loans to the company

What is share of profit of associates

Share of profit of associates occurs when one company's investment in another company creates significant influence without gaining control, and when each company has its own financial statements.

It is the cost method?

The cost method of accounting is primarily used for ownership holdings that do not result in significant influence (traditionally ownership of less than 20%) and where investments in other companies are reported in the form of investments on the financial statements.

What is income tax expense?

Income tax expense includes both current tax and deferred tax for the time period. The notes to the company's financial statements provide additional information on this topic.

What is the next step in statement of comprehensive income?

The next step in the statement of comprehensive income is the calculation of profit (or loss).This is the amount of profit from the year's operations that may be available for distribution to shareholders.

What is the statement of equity used for?

The statement of changes in equity is used to record changes to each component of equity, including share capital and retained earnings (items 11 and 12 on the statement of financial position). It also records any change in noncontrolling interest (item 13 on the statement of financial position).

What is the statement of changes?

The statement of changes in equity shows the company's total comprehensive income in the form of retained earnings. It also shows the amount of total comprehensive income that is attributable to non-controlling interests.

What should be some of the question you should be asking to evaluate the liquidity and solvency?

• Can the company pay its creditors, especially in business downturns?

• Can it fund its needs internally, if necessary?

• Can it reinvest while continuing to pay dividends to shareholders?

What does the cash flow statement show?

• Operating Activities

• Financing Activities

• Investing Activities

What does the statement of cash flows show?

The statement of cash flows begins by looking at those accounts that directly reflect the business activities of the company.

What are some net working capital item included?

• Trade receivables

• Inventories • Trade payables

• Interest payable

• Taxes payable

When are transaction used to finance the company?

• If the company has issued new share capital (item 38) or debt (item 40), cash flows into the company.

• If the company repays debt (item 39) or pays dividends to the shareholders (item 41), cash flows out of the company

What does investing actives show?

Investing activities highlight what the company did with any money not used in its direct operation. This section includes any investments made in the company itself, such as the purchase of new capital assets or disposal of such assets.

What does the final section of the finance do?

The final section of the statement of cash flows sums up the cash flows from operating, investing, and financing activities to arrive at the increase or decrease in cash for the current fiscal year.

What needs to be done with the financial condition of the company?

A considerable amount of detailed information about a company's financial condition must be disclosed in the shareholders' interest.

Under Canadian corporate law what is need to be done?

Canadian corporate law requires that every limited company appoint an auditor to represent shareholders and report to them annually on the company's financial statements.

What does the some province requires companies to do?

Securities legislation in each of the provinces requires the continuous disclosure of certain prescribed information concerning the business and affairs of public companies.

What is a reporting issuer?

A reporting issuer is a corporation that has issued securities to the public and must comply with the timely and continuous public disclosure requirements of the securities acts. The primary disclosure requirements include issuing a press release and filing a material change report with the administrators, if a material change occurs.

What financial disclosure provisions is required for the shareholders?

• Comparative audited annual financial statements should be sent within 120 days of the financial yearend, for companies listed on the TSX Venture Exchange, or within 90 days, for senior issuers on the TSX.

• Comparative unaudited quarterly interim financial statements should be sent within 60 days of the end of each of the first three quarters of the financial year, for companies listed on the TSX Venture Exchange, or within 45 days, for issuers on the TSX.

What are the withdrawal right for investor?

Securities legislation in all provinces provides purchasers with the right to withdraw from an agreement to purchase securities within two business days after receipt or deemed receipt of a prospectus or any amendment to the prospectus. The purchaser must give notice to the vendor or its agent.

What are the right of rescission?

Securities legislation gives purchasers the right to rescind or cancel a completed contract for the purchase of securities if the prospectus or amended prospectus offering the security contains a misrepresentation. This right is provided on condition that the action to enforce it is brought within the applicable time limits. In most provinces, a purchaser alleging misrepresentation must choose between the remedy of rescission and the alternative of damages.

What are the right of action for damages?

The right of action for damages as granted by most securities legislation provides that an issuer and its directors, and anyone who signs a prospectus, may be liable for damages if the prospectus contains a misrepresentation.

What is a takeover bid?

A takeover bid is an offer to purchase from a company's shareholders more than 20% of the outstanding voting securities of the company (or a number of shares that, when combined with the offeror's existing shares, exceeds 20%).

How does early warning discloser happen?

Most provincial acts state that every person or company accumulating 10% or more of the outstanding voting securities of any class of a reporting issuer, or securities convertible into such securities, must issue a press release immediately.

What does insider trading include?

• the directors of the issuer;

• the senior officers of the issuer, who are defined as the chair or vice-chair of the board of directors, the president, any vice-president, the secretary, the treasurer or the general manager of the issuer, or any other individual who performs functions for the issuer similar to those normally performed by an individual occupying any such office, and each of the five highest paid employees of the issuer, including any individual referred to above;

• any person or company (excluding underwriters in the course of public distribution) beneficially owning, directly or indirectly, or controlling or directing more than 10% of the voting rights attached to all voting securities; and

• any director or senior officer of a company that is a subsidiary of the issuer or is itself an insider due to ownership, control or direction over more than 10% of the voting rights attached to all voting securities of the issuer involved.

What must be done when reporting insider trading?

Insiders must inform the relevant securities commissions when they become insiders and when they transact in securities of the company in which they are insiders. Reports must state the extent of the insider's direct or indirect beneficial ownership of, or control or direction over, securities of the company. Securities firms should be aware that most acts require an insider who transfers securities of a reporting issuer into the name of an agent, nominee, or custodian to file a report with the administrator. Transfers for the purpose of collateral for a debt are exempt from this rule.