Exploring Organization and Share Capital Transactions

BAT4M Grade 12 University College Accounting Chapter 13 Test Corporations: Organization and Share Capital Transactions Corporation – legal entity separate from owners – owners are known as shareholders – shares most of the rights and privileges of a person – can be profit or not-for-profit and also an income trust – publicly traded corporations have shares that are often traded on a stock market such as the TSX – privately traded corporations, AKA closely held corporations, have few shareholders and shares that are not traded on the market Characteristics of a Corporation Separate Legal Existence – the corporation acts under its own name and as a single person – the acts of shareholders do not bind to the corporation Limited Liability of Shareholders –A big benefit of a company is that each shareholder is only responsible for the amount they invested; their personal assets are not at risk. However, creditors may ask more powerful stockholders for personal guarantees, which might put their personal assets at risk. Transferable Ownership of Rights – The corporation does not need to approve any transfers made by shareholders, and they have no impact on how the company operates because they take place on a personal basis. Ability to Acquire Capital – corporation can simply issue shares to acquire capital from investors – large corporations will often be able to issue many shares – small corporations may find it tough to issue their shares Continuous Life – corporations continue operating even if there is a death/withdrawal of anybody associated with the corporation – corporations have unlimited life Corporation Management – board of directors selected by shareholders control the operations of the corporation – the board of directors can be comprised of anyone Government Regulations – corporations can be incorporated either federally or provincially – government laws regulate the issuing of shares, distribution of income and reacquisition of shares – increases costs to adhere to government regulations Income Tax – does not act similar to a proprietorship or partnership where income tax was paid personally by each owner – corporations pay federal and provincial taxes as a single person would – shareholders pay taxes on cash dividends but receive credit to reduce the amount of tax – shareholders don’t pay taxes on net income of the corporation until it is distributed Advantages of a Corporation – Corporation Management – professional board of directors – Separate Legal Existence – acts of owners do not bind to the corporation – Limited Liability of Shareholders – owners only liable for their investment – Income Tax – income tax can be reduced or deferred by corporations – Transferable Ownership of Rights – ownership is easily exchanged and does not affect the corporation – Ability to Acquire Capital – large corporations can easily acquire capital by simply issuing shares – Continuous Life – if anyone associated with the corporation withdraws/dies, the corporation continues to run as normal Disadvantages of a Corporation – Corporation Management – shareholders often have very little say in the management of the corporation – Government Regulations – can be costly to adhere to government regulations – Income Tax – corporations are initially taxed for their net income, and once distributed, shareholders are once again taxed Forming a Corporation – To form a corporation, certain documents must be filed – These files include: name and purpose of corporation, document regarding the share capital and number of shares, names and addresses of founders, and location of corporation headquarters – Corporations must get a license in every province they are active – Organization costs are any costs that incur while forming the corporation – Organization costs can include legal fees, accounting fees, and registration costs – Often expensed in the year of Ownership Rights of Shareholders – Common shares allow shareholders to: vote, acquire dividends, and claim liquidated assets – Shareholders can vote on the election of the board of directors or other large matters – each share is worth one vote – Shareholders receive dividends proportionate to the number of shares they have – Shareholders can claim liquidated assets proportionate to their shares – only occurs if all assets are sold and all liabilities paid Share Issues – Authorized shares – the number of shares a corporation can issue, is specified in the articles of incorporation – can be unlimited or a specified amount – Issued shares – number of shares actually sold by the corporation – No journal entry needed for authorization of share capital, but should be disclosed in the notes – Shares can be issued either directly or indirectly – Direct issuing means directly to the investor and usually happens in private corporations – Indirect issuing means the selling of shares to investors through a broker and usually happens in public corporations – Initial Public Offering (IPO) – first time shares are offered by the corporation to the public – assets and shareholder’s equity accounts increase – Market price per share changes depending on the speculation of the company’s operations – Share Capital: amount contributed by shareholders to the corporation – Retained Earnings: earned capital kept for future use – retained earnings = net income – losses and amounts distributed to shareholders – Retained earnings can be distributed to shareholders or kept on hold – Share capital cannot be distributed to shareholders – must stay in the corporation as protective measure for creditors of the corporation – Share capital is legal capital – Par value used to be assigned to determine legal capital, but is often illegal in many provinces and federally – No Par Value Shares: shares with no specific value – No par value shares are normally issued inCanadaand the proceeds from these shares go to legal capital Common Shares – Contributed capital is the share capital plus any other amounts invested by shareholders – When no par value shares are issued, DR Cash (# of shares X share price), CR Common Shares (# of shares X share price) – When exchanging shares for services/noncash assets, DR Expense or noncash asset (market value of shares X number of shares), CR Common Shares à Do not record at billed price – When market value cannot be determined, DR Expense/non cash asset for the amount of bill/appraisal, CR Common Shares Reacquisition of Common Shares – Corporations will reacquire their shares by purchasing them on the market to: – Increase trading volume which could encourage people to purchase more shares – Increase earnings per share by removing shares issued – Remove incompliant shareholders – Keep extra shares on hand to be reissued through bonuses or compensation plans – Adhere to percentage share ownership requirements – When shares are reacquired, they are removed completely and cancelled – shares become authorized and unissued – Often announced in newspapers – To record: remove shares from share capital account, record cash paid, record gain or loss on reacquisition – Average cost per share = common shares / number of shares issued – To remove shares from share capital in a situation where average cost is greater than reacquisition price (“gain” situation): DR Common Shares for amount of shares reacquired X average cost per share, CR Contributed Capital (difference between common shares and cash) and Cash (amount of shares reacquired X reacquisition price) – To remove shares from share capital in a situation where average cost is less than reacquisition price (“loss” situation): DR Common Shares (amount of shares reacquired X average cost per share) and Retained Earnings (difference between cash and common shares), CR Cash (amount of shares reacquired X reacquisition price) Preferred Shares – Preferred shareholders have priority over common shareholders for dividends and assets – Often do not receive voting rights – Functions similar to a common share – Cumulative Dividend: preferred shareholders receive current year dividends and any dividends unpaid from previous years before common shareholders receive any dividends – Dividends in Arrears: preferred dividends not declared in a period when preferred shares are cumulative – Noncumulative: when dividend is not paid, it cannot be paid for later – Majority of preferred shares are noncumulative – Dividends in arrears are not considered liabilities even though they should be paid – the corporation is not legally obligated to pay – Convertible Preferred Shares: shareholders have the option of exchanging preferred shares for common shares at a certain ratio – To convert shares: DR Preferred Shares (number of shares being exchanged X average cost per share), CR Common Shares for same amount à Do not take market value because the corporation is not gaining anything extra – Redeemable/Callable Preferred Shares: give the corporation the right to purchase shares from shareholders in the future for a set price – Gives the corporation flexibility to manage their preferred shares – Retractable Preferred Shares: These shares can be redeemed by shareholders rather than the corporation; they function similarly to redeemable Shares in that the shareholders determine when the corporation must repurchase Shares. – Financial Instrument: contract between two or more parties that establishes financial rights or obligations – A/R and A/P are examples of financial instruments – If the corporation goes bankrupt, preferred shareholders will get money back before common shareholders will be able to – However, creditors still receive liquidated preference before preferred shareholders Presentation Contributed Capital: contains Share Capital (preferred shares and common shares) and Additional Contributed Capital (reacquisition or retiring of shares) – in the share capital section, legal value, amount of authorized shares, amount of shares issued, and any extra share information is reported for each share class Retained Earnings: cumulative net income/loss – each year, this account is increased/decreased by net income/loss and is decreased by dividends – revenue and expense accounts are closed to this account at the end of the year – normal balance is CR, but if there is a DR balance, there is a deficit – if deficit exists, shareholders’ equity is decreased rather than increased Accumulated Other Comprehensive Income: includes all changes in shareholders’ equity except for changes as a result of sales or repurchases of shares or payment of dividends – includes revenues, expenses, gains, and losses – protective measure to keep income safe from fluctuations in market value – informs of any additional gains/losses Return on Equity Ratio – AKA return on investment – How many dollars are earned for each dollar invested by shareholders – Return on Equity = Net Income / Average Shareholders’ Equity – Can be done with just common shares as well – Common Shareholders’ Equity = Total Shareholders’ Equity – Preferred Shares legal capita