CH 11 Equity and Shareholder Transactions

Study Objectives

  • Understand major characteristics of a corporation:
    • Separate legal entity
    • Rights and privileges similar to a person
    • Classified by purpose (profit vs not-for-profit) and ownership (public vs private).
  • Record transactions:
    • Common and preferred share transactions
  • Prepare entries for dividends and splits:
    • Cash dividends, stock dividends, stock splits
  • Presentation of shareholders’ equity in financial statements.
  • Evaluate dividend and earnings performance.

Characteristics of a Corporation

  • Separate Legal Existence: Corporation is distinct from owners.
  • Limited Liability: Shareholders' liability limited to their investment.
  • Transferable Ownership Rights: Shares can be sold or transferred.
  • Ability to Acquire Capital: Corporations can raise funds by selling shares or issuing debt.
  • Continuous Life: Corporations continue to exist even if ownership changes.
  • Management Structure: Managed by a board of directors and officers.
  • Regulated by Government: Subject to various laws and regulations.
  • Income Tax Liability: Corporations pay taxes on their income.

Advantages and Disadvantages of Corporations

  • Advantages:
    • Professional management
    • Limited liability for owners
    • Potential tax benefits
    • Share ownership is transferable
    • Easier capital acquisition
    • Business continuity
  • Disadvantages:
    • Increased regulatory costs and complexity
    • Additional income taxes compared to other structures.

Share Issuance Considerations

  • Raising Capital: Corporations sell ownership rights as shares or issue debt.
  • Types of Shares: Common shares and preferred shares, each with specific rights outlined in articles of incorporation.
  • Authorized Share Capital: Maximum allowable shares; disclosed, not recorded.
  • Issued Shares: Number of shares sold; legal capital cannot be distributed like retained earnings.

Issuing Shares

  • Initial Public Offering (IPO):
    • Company sets the share price (e.g., Apple Inc. at $22/share).
    • Shares trade on exchanges at market-determined prices post-IPO.

Common and Preferred Shares

  • Common Shares: Contributed capital paid by shareholders; issued for cash or equivalent value (services/assets).
  • Preferred Shares: Priority over common shares in dividends and liquidation without voting rights.

Dividend Types

  • Cash Dividends: Distribution of cash to shareholders; requires solvency test and formal declaration by the board.
  • Stock Dividends: Issued in shares; affects retained earnings and increases the number of shares without changing total equity.

Key Events in Dividends

  • Declaration Date: Board authorizes dividends; creates legal obligation.
  • Record Date: Determines eligibility for dividends.
  • Payment Date: Date when dividends are paid.

Effects of Dividends and Splits

  • Cash Dividends: Reduce retained earnings and create a liability on declaration date.
  • Stock Dividends: Transfer amount to Stock Dividends account, increase common shares.
  • Stock Splits: Increase shares based on ownership percentage; decrease market value proportionately.

Shareholders’ Equity Presentation

  • Components:
    • Contributed Capital: Common and preferred shares.
    • Retained Earnings: Profits retained for reinvestment.
    • Accumulated Other Comprehensive Income: Includes certain gains/losses excluded from profit.

Performance Measurement Metrics

  • Dividend Record:
    • Payout Ratio:
    • Cash dividends relative to profit.
    • Dividend Yield:
    • Income per share relative to market price.
  • Earnings Performance:
    • Earnings per Share (EPS): Profit allocated to each common share.
    • Return on Equity (ROE): Profitability from shareholders' perspective; measures efficiency and profitability of equity use.