Corporations: Additional Topics and IFRS Study Notes

Chapter 14: Corporations: Additional Topics and IFRS Learning Objectives

• Explain how to account for stock dividends and stock splits, including a comparison of their financial impact.

• Explain how to account for the reacquisition of shares, focusing on retirement and cancellation of shares.

• Prepare an income statement showing continuing and discontinued operations, and prepare a statement of comprehensive income.

• Explain the different types of accounting changes and account for the correction of a prior period error.

• Prepare a statement of changes in shareholders’ equity to reflect complex corporate events.

• Explain earnings and dividend performance and calculate performance ratios such as EPS, Price-Earnings ratio, and Payout ratio.

Additional Share Transactions: Stock Dividends and Splits

Definitions and Characteristics

• Stock Dividends:

  • A distribution of the corporation’s own shares to its shareholders.

  • The dividend is distributed in shares instead of cash.

  • Accounting Effect: Results in a decrease in Retained Earnings and a corresponding increase in Share Capital (specifically Common Shares).

• Stock Splits:

  • The issuance of additional shares to shareholders according to their current percentage ownership.

  • Accounting Effect: No formal journal entries are required because it does not change the total dollar amount of shareholders’ equity; it only changes the number of shares and, potentially, the par or stated value.

Reasoning for Distributions

Practical Example: BE14.1 (Stock Dividend Journalization)

• Scenario: On March 1, Houseboat Ltd. had $400,000$ common shares issued with a balance of $\$600,000$. A $5\%$ stock dividend was declared for shareholders of record on March 14, distributed on March 31.

• Fair Value Data:

  • March 1: $\$5$ per share

  • March 14: $\$4.85$ per share

  • March 31: $\$5.35$ per share

• Calculation:

  • Number of shares to distribute: $400,000 \times 5\% = 20,000$ shares

  • Value at declaration (March 1): $20,000 \times \$5 = \$100,000$

• Journal Entries:

  • March 1 (Declaration Date):

    • Debit: Stock Dividends $\$100,000$

    • Credit: Stock Dividends Distributable $\$100,000$

  • March 14 (Date of Record):

    • NO ENTRY

  • March 31 (Distribution Date):

    • Debit: Stock Dividends Distributable $\$100,000$

    • Credit: Common Shares $\$100,000$

Comparison of Financial Impacts

Reacquisition of Shares

Theoretical Basis

• Action: Reacquired shares are retired and cancelled in most jurisdictions.

• Purpose for Reacquisition:

  • To increase trading on securities markets.

  • To increase earnings per share (by reducing the number of outstanding shares).

  • To buy out hostile shareholders.

  • To have shares available for compensation plans or other corporate uses.

Accounting for Reacquisition: BE14.8

• Initial Data (Dec 31, 2027): $40,000$ common shares issued; Balance = $\$250,000$.

• Average Cost Calculation:

  • $\frac{\$250,000}{40,000 \text{ shares}} = \$6.25 \text{ per share}$

• Transactions (April 5, 2028): Reacquire $8,000$ shares.

  • Scenario (a): Paid $\$45,000$

    • Debit: Common Shares ($8,000 \times \$6.25$) $\$50,000$

    • Credit: Contributed Surplus $\$5,000$

    • Credit: Cash $\$45,000$

  • Scenario (b): Paid $\$60,000$

    • Debit: Common Shares ($8,000 \times \$6.25$) $\$50,000$

    • Debit: Retained Earnings $\$10,000$

    • Credit: Cash $\$60,000$

Comprehensive Reacquisition Problem: E14.5

• History:

  1. Jan 6: Issued $200,000$ common shares for $\$1.50$ = $\$300,000$.

  2. Jan 12: Issued $50,000$ common shares for $\$1.75$ = $\$87,500$.

  3. Mar 17: Issued $1,000$ preferred shares for $\$105$ = $\$105,000$.

  4. July 18: Issued $1,000,000$ common shares for $\$2$ = $\$2,000,000$.

• Calculating Average Cost Before Reacquisition:

  • Total Shares = $200,000 + 50,000 + 1,000,000 = 1,250,000$

  • Total Value = $\$300,000 + \$87,500 + \$2,000,000 = \$2,387,500$

  • Average/Share = $\frac{\$2,387,500}{1,250,000} = \$1.91$

• Nov 17 Reacquisition: $200,000$ shares for $\$1.95$.

  • Debit: Common Shares ($200,000 \times \$1.91$) $\$382,000$

  • Debit: Retained Earnings $\$8,000$

  • Credit: Cash ($200,000 \times \$1.95$) $\$390,000$

• Dec 30 Reacquisition: $150,000$ shares for $\$1.80$.

  • Debit: Common Shares ($150,000 \times \$1.91$) $\$286,500$

  • Credit: Contributed Surplus $\$16,500$

  • Credit: Cash ($150,000 \times \$1.80$) $\$270,000$

Comprehensive Income and Component Disclosures

Discontinued Operations

• Definition: The disposal or reclassification to "held for sale" of a component of an entity (e.g., a separate major business line or geographic area).

• Reporting: Must be reported net of income tax.

Other Comprehensive Income (OCI)

• Reporting Framework: Required under IFRS (Not ASPE).

• Format: Can be presented in an all-inclusive format or as a separate statement.

• Details: Certain gains and losses are excluded from profit but added to/deducted from shareholders’ equity via OCI.

Application: E14.6 Partial Income Statement

• Profit from continuing operations: $\$320,000$

• Discontinued Component data (Pre-tax): $\$90,000$ profit from operations; $\$30,000$ loss on disposal.

• Tax Rate: $30\%$

• Calculations (Net of Tax):

  • Operating Profit: $\$90,000 - (\$90,000 \times 0.30) = \$63,000$

  • Disposal Loss: $\$30,000 - (\$30,000 \times 0.30) = \$21,000$

• Statement Structure:

  • Profit from continuing operations: $\$320,000$

  • Discontinued Operations:

    • Profit on discontinued components operations, net of tax: $\$63,000$

    • Loss on Disposal, net of tax: $\$(\$21,000)$

  • Profit for the year: $\$362,000$

Accounting Changes and Prior Period Errors

1. Changes in Accounting Estimates

• Context: Involves future conditions like bad debt or warranty expenses.

• Triggers: Changes in circumstances or new information.

• Application: Prospective application (start using the new estimate from the current period forward).

2. Changes in Accounting Policies

• Triggers: Required by new IFRS/ASPE guidance or provides more reliable/relevant info.

• Application: Retrospective application (prior years are restated) unless practically impossible.

3. Correction of Prior Period Errors

• Context: Discovery of a material error after financial statements are issued.

• Application: Retrospective restatement.

• Accounting: Correction is made directly to Retained Earnings (since revenues/expenses of prior periods are closed there), net of tax.

Practical Example: E14.8 (Error Correction)

• Error: In 2027, $\$75,000$ purchase of land was recorded as a legal expense.

• Tax Rate: $25\%$

• Correction Entry (2028):

  • Debit: Land $\$75,000$

  • Credit: Income Tax Payable ($\$75,000 \times 25\%$) $\$18,750$

  • Credit: Retained Earnings $\$56,250$

• Statement of Retained Earnings (Adjusted):

  • Balance, Dec 31, 2027 (as previously reported): $\$573,500$

  • Add: Correction of error (Net of tax): $\$56,250$

  • Adjusted Balance, Jan 1, 2028: $\$629,750$

  • Add: Profit: $\$193,000$

  • Less: Cash Dividends: $\$(\$216,000)$

  • Balance, Dec 31, 2028: $\$606,750$

Statement of Changes in Shareholders' Equity

Case Study: Marchelle Incorporated (E14.11)

Key Data:

• Jan 1 Balance: Common Shares $\$2.2$M ($220,000$ shares), Retained Earnings $\$850,000$, Accumulated OCI $\$27,000$.

• July 1: Issued $80,000$ shares at $\$15$ ($\$1.2$M).

• Sept 30: 3-for-2 Stock Split. Total shares = $300,000 \times \frac{3}{2} = 450,000$.

• Dec 9: Declared $5\%$ stock dividend ($450,000 \times 5\% = 22,500$ shares). Fair value = $\$22$. Total dividend value = $22,500 \times \$22 = \$495,000$.

• Profit: $\$390,000$.

• OCI Loss (Equity Inv): $\$38,000$ before tax. Net of $25\%$ tax = $\$38,000 \times 0.75 = \$28,500$ loss.

Statement Construction:

Reporting Summary and Performance Ratios

Impact of Transactions on Shareholders' Equity

• Issuance of Shares: Increases Share Capital.

• Reacquisition: Decreases Share Capital; may decrease Retained Earnings or increase/decrease Contributed Surplus.

• Prior Period Error: Increases/Decreases Retained Earnings.

• Change in Policy: Increases/Decreases Retained Earnings.

• Dividends (Cash/Stock): Decreases Retained Earnings.

• Stock Split: Increases share count; no effect on dollar balances.

Performance Ratios

1. Earnings Per Share (EPS):

   • Formula: $\text{EPS} = \frac{\text{Profit} - \text{Preferred Dividends}}{\text{Weighted Average Number of Common Shares Issued}}$

   • Note: If preferred shares are cumulative, reduce profit by the annual dividend regardless of declaration. If noncumulative, only reduce if declared.

   • Weighted Average: Shares issued/reacquired must be adjusted for the fraction of the year outstanding.

2. Price-Earnings (PE) Ratio:

   • Formula: $\text{PE Ratio} = \frac{\text{Market Price per Share}}{\text{Earnings Per Share}}$

   • Interpretation: High PE suggests investors expect high future earnings potential.

3. Payout Ratio:

   • Formula: $\frac{\text{Cash Dividends}}{\text{Profit}}$

   • Interpretation: High ratios are common in mature companies with limited growth; low ratios suggest the company is retaining cash for expansion.

Example Balance Sheet (Partial)

HAWTHORN INTERNATIONAL INC.

• Common Shares: $\$2,980,000$ ($1,000,000$ issued)

• Contributed Surplus – Reacquisition: $\$20,000$

• Retained Earnings: $\$3,000,000$

• Accumulated OCI: $\$190,000$ (indicated as $\$385,700$ in transcript text note error; total S/H equity = $\$3,575,700$ implies OCI components or additional items not fully listed).