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 share holders

–          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 – each shareholder is only liable for the amount they invested – the personal assets of shareholders are not at risk – huge advantage of a corporation, but creditors can demand personal guarantees from more powerful shareholders, putting their personal assets at risk

Transferable Ownership of Rights – shareholders can transfer their ownership of the corporation at any time – does not require approval of the corporation – does not affect operation of corporation – transactions occur on a personal level

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/noncash 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: shareholders are able to redeem shares instead of the corporation – essentially works the same as redeemable shares, but the shareholders decide when the corporation must redeem 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 capital