Chapter+14+Notes+-+Corporations

Homework: SS1, SS2, SS3, SS4; BE14-2; E14-1 Highlights: **corporation** defined as **independent legal entity** separate and distinct from its owners (shareholders) - ownership in corporation is evidenced by paper document known as **share or stock** - corporations possess most of the rights and responsibilities held by individuals (right to sue and be sued, right to buy and sell property, right to enter and rescind contracts, right to seek bankruptcy protection, right to borrow money, obligation to file income tax returns, etc., all in name of corporation) - both for **profit and nonprofit** (not-for-profit) corporations exist in Canada today - both **private** **corporations** (less than 50 shareholders, sale of shares to public is prohibited, transfer of shares is restricted by board of directors or other shareholders) and **public** **corporations** (shares openly traded on organized stock exchanges without restrictions) exist in Canada today - **Crown corporations** are essentially private corporations held by federal or provincial government, e.g., Ontario Hydro - for identification purposes, Canadian corporation must include one of Limited, Incorporated or Corporation or standard abbreviation equivalent (Ltd., Inc., Corp.) at end of corporate name
 * __SO 1 - 2__**

- **advantages** of corporations include: **independent legal existence** (corporations exist as separate and distinct entities from its owners, namely shareholders, so that actions of shareholders do not bind corporation as they often do with respect to partnerships), **limited liability of shareholders** (shareholder liability limited to his/her investment in firm so that personal assets of shareholder can not be used to satisfy debts of corporation), **ease of ownership transfer** (shareholders can buy and sell shares in public corporation within secondary markets, i.e., stock exchanges, without seeking consent of board of directors or other shareholders), **ability to raise capital** (additional financing/capital/funds can be raised by sale of additional shares to public), **corporate continuity** (unlike partnership, corporate life is not threatened by death, incapacity or bankruptcy of individual shareholders), **professional corporate management** (corporate operations managed by **board of directors** duly elected by common shareholders at annual general meeting [AGM], although risk of ownership/management divide may present difficulties; directors may then hire qualified officers, e.g., CEO, Vice-Presidents, to oversee day-to-day affairs of firm

- **disadvantages** of corporations include **strict government oversight** (federal and provincial securities regulations protect individual shareholders' interests from risk of corporate fraud and mismanagement, although at price of increased cost and complexity), **double taxation of corporate profits** (small Ontario private corporations pay approximately 15-26% annual income tax on corporate profits with eligible deductions and tax credits [which may still be less than individual income tax rates] while distributions of remaining profits are taxed in hands of individual shareholders in the form of dividends)

- corporations are formed by filing **articles of incorporation** either federally or provincially - organization costs (registration fees, legal fees, etc.) are treated as expenses in year of corporate formation

- ownership in corporation evidenced by paper document known as **share certificate** listing type of share and number of shares held, inter alia

- shares may be classified as either **common** (usually voting) or **preferred** (usually non-voting) - all corporations must offer common shares, while preferred shares are optional -> in other words, if a corporation only has one class of share, that share class must be common - Class "A" (most often common) and Class "B" (most often preferred) shares are other terms commonly used to describe corporate share types

- **common shareholders** entitled to **elect board of directors** at annual general meeting of shareholders (AGM) and vote on significant issues requiring shareholder approval

- all shareholders (first preferred and then common) are entitled to pro rata **share of** **proceeds of sale upon liquidation of corporate assets** following bankruptcy proceedings, but only after all creditors (government, banks, suppliers, etc.) have been satisfied

- articles of incorporation may or may not specify __maximum__ number of shares __available__ for sale but not yet sold, known as **authorized share capital**

- contrast authorized share capital with **issued share capital** which refers to number of shares actually sold to public and currently **outstanding** (see below for exception re: treasury shares)

- in most cases, articles of incorporation simply authorize "unlimited" number of shares available for sale so as to avoid necessity of altering articles of incorporation in the event that corporation wishes to issue (sell) additional shares above and beyond its original authorized capital figure

- sales of __new__ shares to the public often require services of underwriters, investment dealers or brokerage houses to facilitate share distribution in the **primary market** - first offering of public corporation shares to public is known as **IPO** (initial public offering)

- thereafter, shares in public corporations are continually traded (bought and sold) in **secondary market** via established **stock exchanges** (e.g., TSX, NYSE) and over-the-counter (OTC) electronic discount exchanges - share price in secondary markets may fluctuate wildly and is largely function of supply and demand and other social, economic and political factors

- **daily share listings / stock tables** refer to 52-week high and low trading prices, stock name and ticker symbol (e.g., Microsoft and MSFT), annual dividends per share, dividend yield (annual dividend / current share price), P/E ratio (ratio of current share price to annual earnings per common share), trading volume (number of shares sold during most recent trading day), daily high and low trading prices, closing share price at end of most recent trading day, and change from previous day's closing price to today's closing price

- shares may be classified as either **par value, no par value** or **stated value**

(1) **par value** **shares** refer to share capital with **specific value stated in articles of incorporation** as determined by corporation's founders - par value represents **legal capital** per share but in no way corresponds to current market price per share in secondary market (stock exchange) - par value shares can __not__ be legally sold by corporation for less than their par value - par value shares are **very rare in Canada** today and have even been banned in several jurisdictions including Ontario

//(**legal capital refers to capital that must be retained within the corporation for the protection of creditors and cannot be withdrawn by shareholders - legal capital also refers to specific amount that must be credited to ordinary Capital account [e.g., Share Capital/Capital Stock/Common Shares/Preferred Shares, etc.] upon sale of shares by corporation)**//

(2) **no par value** **shares** have **__not__ been assigned specific value by corporation in articles of incorporation** and so for accounting purposes, legal capital of no par value shares (credited to ordinary Capital account) is simply equivalent to **actual proceeds of sale** upon sale of shares - no par value shares can be sold at __any__ price by board of directors and sale price may vary from issuance to issuance - no par value shares are **extremely common in Ca** **nada** today amongst public corporations

(3) **stated value shares**: in some provinces the **board of directors may publicly assign a stated value to no par value shares** which then becomes the **legal capital per share** (credited to ordinary Capital account) for accounting purposes (see above) - board of directors may __vary__ the stated value per share with each new sale of shares - like par value, stated value in no way corresponds to current market price per share in secondary market (stock exchange) and like par value shares, stated value shares can __not__ be legally sold by corporation for less than their stated value - stated value shares are also **fairly uncommon** among Canadian corporations today

// - to summarize then, stated value represents legal value per share and also minimum sale price per share //

- **shareholders' equity** section of corporate balance sheet refers to both **contributed capital** (capital contributed by shareholders equivalent to full purchase price of shares in primary market, e.g., Share Capital account, Paid-In Capital account - see below) and **retained earnings** (accumulated profits retained in business since incorporation that have not been distributed to shareholders in form of dividends) - retained earnings account is employed at fiscal year end in order to update equity balance via **closing entries (R/E/D)**:

.............. ** Retained Earnings - cr - 100,000 **
 * (i) __R__evenues - dr - 100,000 **

................................ ** Expenses - cr - 80,000 **
 * (ii) Retained Earnings - dr - 80,000 **

............................. ** Dividends - cr - 15,000 **
 * (iii) Retained Earnings - dr - 15,000 **

Homework: SS5, SS6; BE14-4, BE14-5, BE14-6; E14-2, E14-3 Highlights: board of directors may issue common (usually voting) shares at any time - all corporations must issue at least one common share
 * __ SO 3 - Accounting for Common Shares __**

- when **no par value common shares** are issued (sold) for cash, the __entire__ proceeds of sale constitute both legal capital (Share Capital contributed capital account) and contributed capital regardless of sale price

Cash - dr - 10,000 ........... Share Capital - Common - cr - 10,000 To record issue of 10,000 no par value common shares for $1 per share

Cash - dr - 50,000 .......... Share Capital - Common - cr - 50,000 To record further issue of 10,000 no par value common shares for $5 per share


 * **legal capital and contributed capital are both $60,000 after the above two transactions**

- on the other hand, when **stated value common shares** are issued for cash, __only the stated value__ constitutes **legal capital** (ordinary Capital account) while any proceeds of sale __in excess__ of the stated value are added to a __separate__ contributed capital account known as **Paid-In Capital, Contributed Capital in Excess of Stated Value, Additional Paid-In Capital or Contributed Surplus** - Paid-In Capital represents contributed capital but not legal capital

- **stated value effectively determines __maximum__ __legal__ capital that may be recorded whether shares are issued for cash (see immediately below) or for non-cash assets or services (see below)**

- as previously discussed, stated value as determined by the board of directors does not necessarily represent share's secondary market value on a stock exchange, and securities legislation requires that cash proceeds from issue of stated value shares must be equal to or greater than stated value, but never less than stated value

Cash - dr - 10,000 ........ Share Capital - Common - cr - 10,000 To record issue of 10,000 $1 stated value common shares for $1 per share

Cash - dr - 50,000 .......... Share Capital - Common - cr - 10,000 .......... Paid-In Capital - cr - 40,000 To record issue of 10,000 $1 stated value common shares for $5 per share


 * **legal capital is only $20,000 while contributed capital is $60,000 after the above two transactions**

//- to summarize with respect to stated value shares, contributed capital represents full sale price while legal capital represents stated value only//

- accounting entries for **par value common shares** issued for cash (although rare in Canada) are similar to those for stated value shares

- when **common shares are issued in exchange for non-cash assets** (e.g., equipment) **or services** (e.g., legal services), sale of shares should be recorded at their **cash equivalent price** pursuant to cost principle - cash equivalent price is either (i) **fair market value of consideration given up by corporation (i.e., market price of shares)** or, if such value can not be determined (ii) **fair market value of consideration received by corporation (i.e., market value of non-cash assets or services)**

Equipment - dr - 100,000 ........... Share Capital - Common - cr - 100,000 To record issue of 20,000 **no par value** common shares publicly traded at $5 per share in exchange for equipment valued at $120,000

Equipment - dr - 100,000 ............ Share Capital - Common - cr - 80,000 ............ Paid-In Capital - cr - 20,000 To record issue of 20,000 **$4 stated value** common shares publicly traded at $5 per share in exchange for equipment valued at $120,000 (stated value determines maximum legal capital)

Legal Expense - dr - 10,000 ............. Share Capital - Common - cr - 10,000 To record issue of 10,000 **no par value** common shares in private corporation (with no established market price) in exchange for $10,000 in legal services according to bill delivered by law firm

- **dividends** are only paid on common shares once preferred shares have received their dividends, if any - unlike preferred shares, dividends on common shares are not fixed or predetermined

- **re-acquisition of shares by issuing corporation**: public corporations may elect to purchase/buy back their own shares (see **redeemable** and **retractable** **shares** in SO4 below) on the open market (i.e., public stock exchange) at current market prices for a variety of reasons:


 * to increase trading -> to stimulate demand -> to enhance market price of shares
 * to reduce number of shares outstanding -> to increase earnings per share (EPS)
 * to have additional shares available for reissue to employees under bonus or stock option plans
 * to thwart hostile takeover attempts
 * to comply with legislated corporate ownership restrictions

- __federally__ incorporated companies that reacquire their own shares must retire (cancel) shares immediately according to Canadian securities legislation so that shares are returned to status of authorized but neither issued nor outstanding

- in rare circumstances, some __provincially__ incorporated firms in Canada may be legally permitted to reacquire their own shares for future use (known as **treasury shares**), thereby resulting in odd scenario of numerical difference between shares issued (sold) and shares outstanding (shares previously issued and currently held __outside__ company)

Homework: SS7; BE14-7; E14-5, E14-6 Highlights: board of directors __may__ issue **preferred (usually non-voting) shares** in addition to (but not instead of) common shares
 * __SO 4__**

- **preferred shares typically have priority over common shares with respect to (i) payment of dividends and (ii) proceeds of sale upon liquidation of assets following dissolution**

- due to their priority as to dividends and proceeds of sale upon liquidation, preferred shares always appear before common shares under "Contributed Capital" in shareholder's equity section of corporate balance sheet

- like common shares, preferred shares may be issued for cash, non-cash assets or services and may also be reacquired by the corporation - journal entries for issuance of preferred shares are identical to those for common shares (see above) as preferred shares may be no par value, par value or stated value

Cash - dr - 50,000 ............ Share Capital - Preferred - cr - 50,000 To record issue of 10,000 **no par value** preferred shares for **$5 per share**

Cash - dr - 10,000 ............. Share Capital - Preferred - cr - 10,000 To record issue of 10,000 **$1 stated value** preferred shares for **$1 per share**

Cash - dr - 50,000 .............. Share Capital - Preferred - cr - 10,000 .............. Paid-In Capital - cr - 40,000 To record issue of 10,000 **$1 stated value** preferred shares for **$5 per share**

- **payment of dividends**: preferred shareholders must be paid their dividends (assuming dividends are declared in the first place which is entirely within the discretion of the board of directors) before common shareholders can receive any dividends from corporation - dividends can only be declared when retained earnings and cash on hand are sufficient to allow for such distributions of corporate profits to shareholders - unlike common shares, preferred shares typically pay **__fixed, predetermined dividend__** as an annual or quarterly amount per share expressed either in dollars ($1.50/share) or as a percentage of par or stated value (8% dividend on $10 stated value share or 80 cents/share) - board of directors may always increase or decrease amount of fixed, predetermined dividend on preferred shares

- **cumulative preferred shares** offer dividends that accumulate in years when either no dividends are declared or insufficient dividend funds are made available by the board of directors (**dividends in arrears**) - dividends in arrears must be paid in full before current year's preferred and common shareholders can receive any dividends - like any other preferred share, cumulative preferred shares typically pay a fixed, predetermined dividend expressed either in dollars or as a percentage of stock's par or stated value - dividends in arrears do not constitute corporate liability as no legal obligation to pay dividends arises until publicly declared by board of directors; accordingly dividends in arrears should appear in the notes to the financial statements and __not__ in the liability section of the balance sheet

- contrast cumulative preferred shares with **noncumulative preferred shares** where undeclared dividends do __not__ accumulate year over year and need not be paid if not declared within the year

- **convertible preferred shares** grant shareholder the option to exchange preferred shares for common shares at fixed, predetermined ratio (e.g., 1 preferred share for 2 common shares) in order to take advantage of favourable market conditions - convertible preferred shareholders typically convert their shares when it becomes economically advantageous to do so, i.e., when current market value of common shares to be acquired is greater than current market value of preferred shares to be given up - that said, conversion is always recorded using book value (original purchase price) of preferred shares so that current market price of common or preferred shares is __irrelevant__ to journalization of transaction

Share Capital - Preferred - dr - 10,000 Paid-In Capital - dr - 40,000 ......................... Share Capital - Common - cr - 50,000 To record conversion of 10,000 $1 stated value preferred shares originally sold at $5 per share (current market price = $2/share) into 20,000 common shares (current market price = $1.10/share)

- like common shares, corporation may elect to **re-acquire** or **buy back** their own preferred shares on the secondary market and then cancel/retire said shares


 * (i) redeemable (callable) preferred shares** grant the issuing __corporation__ the option to buy back (and then typically cancel/retire) the shares from current shareholders at a predetermined price and within a predetermined time frame, e.g., no par value preferred share redeemable at $8.80/share within 12 months of issue


 * (ii) retractable** ** preferred shares ** grant the __shareholder__ the option to force the corporation to buy back (and then typically cancel/retire) his/her shares at a predetermined price and within a predetermined time frame

- redeemable and retractable preferred shares share many similarities with debt as they both offer returns on investment (dividends) and the possible repayment of principal, and so such shares are typically listed in liabilities section (and not equity section) of corporate balance sheet

- as previously stated, preferred shareholders also have **priority** over common shareholders (but not secured or unsecured creditors) with respect to **proceeds of sale upon** **liquidation of corporate assets** following dissolution, so that preferred shareholders must be paid from sale of corporate assets before common shareholders receive any compensation

Homework: SS8, SS9; BE14-8, BE14-9; E14-7 (a-c) only, E14-9 (b) only, E14-10 (b) only Highlights: ** shareholders' equity section ** **of a corporate balance sheet presents both (i) contributed capital** and (ii) **retained earnings** (see p. 667)
 * __SO 5 & 6__ **

..... **Contributed capital**
 * Shareholders' equity**

........... **Share capital (Legal capital)** ................. Preferred shares, $50 stated value, 6% cumulative, 100,000 authorized, 24,000 issued.............$1,200,000 ................. Common shares, no par value, unlimited number of shares authorized, 500,000 issued.............__$4,000,000__ ...................... Total share capital.....................................................................................................................$5,200,000

........... **Additional contributed capital** ................. Contributed capital in excess of stated value (Paid-in-capital) - preferred shares.............................__$40,000__

...................... Total contributed capital............................................................................................................$5,240,000

..... **Retained earnings**......................................................................................................................................__$900,000__

...................... Total shareholders' equity.........................................................................................................$6,140,000

- ** contributed capital ** includes both ** share capital ** ( __ legal value __ of common and preferred shares equivalent to their par value, full proceeds of sale of no par value shares or stated value) and ** additional contributed capital ** (proceeds of sale in excess of par or stated value) known as Paid-in Capital or Contributed Capital in Excess of Stated/Par Value

- share presentation includes share type, annual dividend on preferred shares expressed either as dollar figure or percentage of par/stated value, and number of shares authorized and issued

**e.g., $5 Preferred shares, no par value, cumulative, convertible at ratio of 1:2, redeemable at $1.50/share within 12 months, 100,000 shares authorized, 30,000 shares issued; Common shares, $8 stated value, unlimited shares authorized, 20,000 shares issued**

- please note that the $5 preferred share mentioned above refers to the __annual dividend__ on the preferred share and not the value of the share itself, and further note that a $5 dividend is equivalent to a 10% dividend on a $50 stated value or par value preferred share

- ** retained earnings ** refers to the accumulated profits of the firm since incorporation less any historical dividends paid out to shareholders


 * __Corporate ratios__**
 * (1) return on equity** (or **return on investment**) is as follows:


 * annual net income / average shareholders' equity (beginning equity plus ending equity divided by two) x 100**

e.g., __**_**$40,000__ ($500,000 + $1,500,000 / 2) x 100

__=__ __$40,000___ $1,000,000 x 100

= 4%


 * (2a) book value per common share for a corporation with common shares __only__ is as follows:**


 * total shareholders' equity (contributed capital & retained earnings) / number of outstanding common shares**

e.g., __$300,000 + $700,000__ ........... 500,000 shares

= $2.00 / share


 * (2b)** **book value per common share** **for a corporation with __both__ common and preferred shares is as follows:**


 * total** **__common__ shareholders' equity only / number of outstanding common** **shares**


 * in order to calculate common shareholders' equity, one must first __ subtract __ the __ legal capital __ of the preferred shares and any __ dividends in arrears __ on cumulative preferred shares from total shareholders' equity

- book value per __preferred share__ is generally __not__ calculated for public corporations

- for shares traded on public stock exchanges like the TSX or NYSE, book value per common share may or may not be related to that share's __market price__

media type="youtube" key="hBvUrchek1I" width="560" height="315"