LO1 – Identify and explain characteristics of the corporate form oforganization and classes of shares.
A corporation is a legal entity that is separate from its owners, known as shareholders. The board of directors is responsible for corporate policy and broad direction of the corporation, including hiring the person in charge of day-to-day operations. A corporation has an indefinite life, its shareholders have limited liability, it can acquire capital more easily than a sole proprietorship or partnership, and it pays income taxes on its earnings since it is a separate legal entity. A corporation can issue common and preferred shares. Common shares have voting rights while preferred shares do not. Preferred shares are listed before common shares in the shareholders’ equity section of the balance sheet. Preferred shareholders are entitled to receive dividends before common shareholders. Authorized shares are the total number of shares that can be issued or sold. Shares that have been issued can be repurchased by the corporation and either held in treasury for subsequent sale/distribution or cancelled. Outstanding shares are those that have been issued and are held by shareholders. Shares repurchased by a corporation are not outstanding shares.
LO2 – Evaluate relative financing effects of bonds, common shares,and preferred shares.
One of the most important considerations between the issue of debt or share capital is the potential effect of each of these financing methods on the present shareholders. These include effects on earnings per share, control of the corporation, and income taxes expense. Differences between projected and actual results can result in wrong decisions.
LO3 – Record and disclose preferred and common share transactions including share splits.
Common and preferred shares can be issued for cash or other assets. Organization costs are expensed when incurred and organizers sometimes accept shares in lieu of cash for their work in organizing the corporation. When more than one type of share has been issued, the shareholders’ equity section of the balance sheet must be classified by including a Contributed Capital section. When a corporations shares are selling at a high price, a share split may be declared to increase the marketability of the shares. There is no journal entry for a share split. Instead, a memorandum entry is entered into the records detailing the split. A share split increases the number of shares but does not change any of the dollar amounts on the financial statements.
LO4 – Record and disclose cash dividends.
Cash dividends are a distribution of earnings to the shareholders and are declared by the board of directors. On the declaration date, cash dividends declared (or retained earnings) is debited and dividends payable is credited. On the date of record, no journal entry is recorded. Shareholders who hold shares on the date of record are eligible to receive the declared dividend. On the date of payment, dividends payable is debited and cash is credited. Preferred shares may have a feature known as cumulative or non-cumulative. Cumulative preferred shares accumulate undeclared dividends from one year to the next. These unpaid dividends are called dividends in arrears. When dividends are subsequently declared, dividends in arrears must be paid before anything is paid to the other shareholders. Non-cumulative preferred shares do not accumulate undeclared dividends.
LO5 – Calculate and explain the book value per share ratio.
The book value of a share is the amount of net assets represented by one share. Book value per common share is the amount of net assets not claimed by creditors and preferred shareholders. Preferred book value per share is the net assets that preferred shareholders would receive if the corporation were liquidated.
LO6 – (Appendix 1) Record and disclose share dividends.
Share dividends distribute additional shares to shareholders and are declared by the board of directors. On the declaration date, share dividends declared (or retained earnings) is debited and common share dividends distributable, a share capital account, is credited. When the share dividend is distributed to shareholders, the Common Share Dividends Distributable account is debited and common shares is credited. Share dividends cause an increase in the number of shares issued and outstanding but do not affect account balances. Share dividends simply transfer an amount from retained earnings to share capital within the shareholders’ equity section of the balance sheet.
LO7 – (Appendix 2) Explain and record restrictions on retained earnings.
Retained earnings can be restricted by the board of directors for certain purposes, like a plant expansion. These restricted amounts are unavailable for dividends. Restrictions do not affect the total amount of retained earnings or total shareholders’ equity. A restriction does not set aside cash to fund the activity. To set up a restriction, the Retained Earnings account is debited and an account ( for example, Retained Earnings – Restriction for Plant Expansion) is credited. When the expansion is complete, the entry is merely reversed.
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