You never know where a humble start might take you. One of the most recognized brands in the world began in 1924 when Adolf “Adi” Dassler became committed to the idea of providing high-quality, sport-specific shoes to athletes. He and his brother stitched together canvas and whatever else he could find in post-World War I Germany to create his shoes. They were so dedicated to their company that they sometimes ran their equipment with electricity generated by riding an exercise bicycle.
Just like today, success in the early years of the Dassler Brothers Shoe Company hinged on affiliations with famous athletes. So it was very fortunate for the brothers that in the 1936 Olympics, their shoes were worn by the famous African-American runner Jesse Owens. After World War II, as a result of a family quarrel, Adi’s brother left and formed his own shoe company, Puma (DEU). Adi renamed his company using a combination of his nickname “Adi” and the first part of his last name, Dassler, to create the now famous name adidas (DEU). In the 1990s, adidas became a publicly traded company for the first time when its shares began to trade on both German and French exchanges.
By becoming a public company, adidas increased its ability to raise funds. It would need these funds in order to compete in the increasingly competitive world of sports apparel. Within two years of going public, adidas AG acquired the Salomon Group (FRA). This acquisition brought in the brands Salomon, TaylorMade, Mavic, and Bonfire. Less than 10 years later, adidas acquired Reebok (GBR). The combination of Reebok and adidas created a company with a global footprint large enough to compete with Nike (USA).
The shoe market is fickle, with new styles becoming popular almost daily and vast international markets still lying untapped. Whether one of these two giants does eventually take control of the pedi-planet remains to be seen. Meanwhile, the shareholders of each company sit anxiously in the stands as this Olympic-size drama unfolds.
Corporations like adidas (DEU) have substantial resources at their disposal. In fact, the corporation is the dominant form of business organization in the world in terms of sales, earnings, and number of employees. In this chapter, we will explain the essential features of a corporation and the accounting for a corporation’s share capital transactions.
The content and organization of Chapter 11 are as follows.
Identify the major characteristics of a corporation.
Many years ago, a noted scholar defined a corporation as “an artificial being, invisible, intangible, and existing only in contemplation of law.” This definition is the foundation for the prevailing legal interpretation in many countries that a corporation is an entity separate and distinct from its owners.
A corporation is created by law, and its continued existence depends upon the statutes of the jurisdiction in which it is incorporated. As a legal entity, a corporation has most of the rights and privileges of a person. The major exceptions relate to privileges that only a living person can exercise, such as the right to vote or to hold public office. A corporation is subject to the same duties and responsibilities as a person. For example, it must abide by the laws, and it must pay taxes.
Two common ways to classify corporations are by purpose and by ownership. A corporation may be organized for the purpose of making a profit, or it may be not-for-profit. For-profit corporations include such well-known companies as Compass Group (GBR), Hyundai Motors (KOR), LUKOIL (RUS), and Google (USA). Not-for-profit corporations are organized for charitable, medical, or educational purposes. Examples are the Salvation Army (USA), the International Committee of the Red Cross (CHE), and the Bill & Melinda Gates Foundation (USA).
Classification by ownership differentiates publicly held and privately held corporations. A publicly held corporation may have thousands of shareholders. Its shares are regularly traded on a national securities exchange such as the São Paùlo Stock Exchange (BRA). Examples are Toyota (JPN), Siemens (DEU), Sinopec (CHN), and General Electric (USA).
In contrast, a privately held corporation usually has only a few shareholders, and does not offer its shares for sale to the general public. Privately held companies are generally much smaller than publicly held companies, although some notable exceptions exist. Cargill Inc. (USA), a private corporation that trades in grain and other commodities, is one of the largest companies in the world.
• Alternative Terminology
Privately held corporations are also referred to as closely held corporations.
A number of characteristics distinguish corporations from proprietorships and partnerships. We explain the most important of these characteristics below.
In most countries, an entity is separate and distinct from its owners. The corporation acts under its own name rather than in the name of its shareholders. Volvo (SWE) may buy, own, and sell property. It may borrow money, and it may enter into legally binding contracts in its own name. It may also sue or be sued, and it pays its own taxes.
In a partnership, the acts of the owners (partners) bind the partnership. In contrast, the acts of its owners (shareholders) do not bind the corporation unless such owners are agents of the corporation. For example, if you owned shares of Volvo, you would not have the right to purchase inventory for the company unless you were designated as an agent of the corporation.
Since a corporation is a separate legal entity, in most countries creditors have recourse only to corporate assets to satisfy their claims. The liability of shareholders is normally limited to their investment in the corporation. Creditors have no legal claim on the personal assets of the owners unless fraud has occurred. Even in the event of bankruptcy, shareholders’ losses are generally limited to their capital investment in the corporation.
Ordinary shares give ownership in a corporation. These shares are transferable units. Shareholders may dispose of part or all of their interest in a corporation simply by selling their shares. The transfer of an ownership interest in a partnership requires the consent of each owner. In contrast, the transfer of shares is entirely at the discretion of the shareholder. It does not require the approval of either the corporation or other shareholders.
The transfer of ownership rights between shareholders normally has no effect on the daily operating activities of the corporation. Nor does it affect the corporation’s assets, liabilities, and total equity. The transfer of these ownership rights is a transaction between individual owners. The company does not participate in the transfer of these ownership rights after the original sale of the ordinary shares.
It is relatively easy for a corporation to obtain capital through the issuance of shares. Investors buy shares in a corporation to earn money over time as the share price grows. Investors also like to invest in shares because they have limited liability and shares are readily transferable. Also, individuals can become shareholders by investing relatively small amounts of money. In sum, the ability of a successful corporation to obtain capital is virtually unlimited.
The life of a corporation is stated in its charter. The life may be perpetual, or it may be limited to a specific number of years. If it is limited, the company can extend the life through renewal of the charter. Since a corporation is a separate legal entity, its continuance as a going concern is not affected by the withdrawal, death, or incapacity of a shareholder, employee, or officer. As a result, a successful company can have a continuous and perpetual life.
Shareholders legally own the corporation. However, they manage the corporation indirectly through a board of directors they elect. The board, in turn, formulates the operating policies for the company. The board also selects officers, such as a president and one or more vice presidents, to execute policy and to perform daily management functions.
Illustration 11-1 (page 540) presents a typical organization chart showing the delegation of responsibility. The chief executive officer (CEO) has overall responsibility for managing the business. As the organization chart shows, the CEO delegates responsibility to other officers. The chief accounting officer is the controller. The controller’s responsibilities include (1) maintaining the accounting records, (2) maintaining an adequate system of internal control, and (3) preparing financial statements, tax returns, and internal reports. The treasurer has custody of the corporation’s funds and is responsible for maintaining the company’s cash position.
The organizational structure of a corporation enables a company to hire professional managers to run the business. On the other hand, the separation of ownership and management often reduces an owner’s ability to actively manage the company.
A corporation is subject to governmental regulations. Laws prescribe the requirements for issuing shares, the distributions of earnings permitted to shareholders, and the effects of retiring shares. Securities laws govern the sale of shares to the general public. Also, most publicly held corporations are required to make extensive disclosure of their financial affairs to securities regulators through quarterly and annual reports. In addition, when a corporation lists its shares on organized securities exchanges, it must comply with the reporting requirements of these exchanges. Government regulations are designed to protect the owners of the corporation.
In most countries, owners of proprietorships and partnerships report their share of earnings on their personal income tax returns. The individual owner then pays taxes on this amount. Corporations, on the other hand, must pay government taxes as a separate legal entity. These taxes can be substantial.
In addition, shareholders must pay taxes on cash dividends (pro rata distributions of net income). Thus, many argue that the government taxes corporate income twice (double taxation)—once at the corporate level, and again at the individual level.
In summary, Illustration 11-2 shows the advantages and disadvantages of a corporation compared to a proprietorship and a partnership.
Illustration 11-2 Advantages and disadvantages of a corporation
Advantages | Disadvantages |
Separate legal existence | Corporation management—separation of ownership and management |
Limited liability of shareholders | |
Transferable ownership rights | Government regulations |
Ability to acquire capital | Additional taxes |
Continuous life | |
Corporation management—professional managers |
The steps for forming a corporation vary somewhat across countries. The initial step in forming a corporation is to file an application with the appropriate governmental agency in the jurisdiction in which incorporation is desired. The application describes the name and purpose of the corporation, the types and number of shares that are authorized to be issued, the names of the individuals that formed the company, and the number of shares that these individuals agreed to purchase. Regardless of the number of jurisdictions in which a corporation has operating divisions, it is typically incorporated in only one state or country.
It is to the company’s advantage to incorporate in a state or country whose laws are favorable to the corporate form of business organization. For example, Gulf Oil (USA) changed its state of incorporation to Delaware to thwart possible unfriendly takeovers. There, certain defensive tactics against takeovers can be approved by the board of directors alone, without a vote by shareholders.
• Alternative Terminology
The charter is often referred to as the articles of incorporation.
After the government approves the application, it grants a charter. The charter may be an approved copy of the application form, or it may be a separate document containing the same basic data. Upon receipt of its charter, the corporation establishes by-laws. The by-laws establish the internal rules and procedures for conducting the affairs of the corporation. Corporations engaged in commerce outside their state or country must also obtain a license from each of those governments in which they do business. The license subjects the corporation’s operating activities to the general corporation laws of that state or country.
Costs incurred in the formation of a corporation are called organization costs. These costs include legal and government fees, and promotional expenditures involved in the organization of the business. Corporations expense organization costs as incurred. Determining the amount and timing of future benefits is so difficult that it is standard procedure to take a conservative approach of expensing these costs immediately.
When chartered, the corporation may begin selling ownership rights in the form of shares. When a corporation has only one class of shares, it is ordinary shares. Each ordinary share gives the shareholder the ownership rights pictured in Illustration 11-3 (page 542). The articles of incorporation or the by-laws state the ownership rights of a share.
Proof of share ownership is evidenced by a form known as a share certificate. As Illustration 11-4 shows (page 542), the face of the certificate shows the name of the corporation, the shareholder’s name, the class and special features of the share, the number of shares owned, and the signatures of authorized corporate officials. Prenumbered certificates facilitate accountability. They may be issued for any quantity of shares.
In considering the issuance of shares, a corporation must resolve a number of basic questions: How many shares should it authorize for sale? How should it issue the shares? At what price should it issue the shares? What value should the corporation assign to the shares? These questions are addressed in the following sections.
The charter indicates the amount of shares that a corporation is authorized to sell. The total amount of authorized shares at the time of incorporation normally anticipates both initial and subsequent capital needs. As a result, the number of shares authorized generally exceeds the number initially sold. If it sells all authorized shares, a corporation must obtain consent of the jurisdiction to amend its charter before it can issue additional shares.
The authorization of ordinary shares does not result in a formal accounting entry. The reason is that the event has no immediate effect on either corporate assets or equity. However, the number of authorized shares is often reported in the equity section. It is then simple to determine the number of unissued shares that the corporation can issue without amending the charter: subtract the total shares issued from the total authorized. For example, if Quanta Computer (TWN) was authorized to sell 100,000 ordinary shares and issued 80,000 shares, 20,000 shares would remain unissued.
A corporation can issue ordinary shares directly to investors. Alternatively, it can issue the shares indirectly through an investment banking firm that specializes in bringing securities to the attention of prospective investors. Direct issue is typical in closely held companies. Indirect issue is customary for a publicly held corporation.
In an indirect issue, the investment banking firm may agree to underwrite the entire share issue. In this arrangement, the investment banker buys the shares from the corporation at a stipulated price and resells them to investors. The corporation thus avoids any risk of being unable to sell the shares. Also, it obtains immediate use of the cash received from the underwriter. The investment banking firm, in turn, assumes the risk of reselling the shares, in return for an underwriting fee. For example, Google (USA) (the world’s number-one Internet search engine) used underwriters when it issued a highly successful initial public offering, raising $1.67 billion. The underwriters charged a 3% underwriting fee (approximately $50 million) on Google’s share offering.
How does a corporation set the price for a new issue of shares? Among the factors to be considered are (1) the company’s anticipated future earnings, (2) its expected dividend rate per share, (3) its current financial position, (4) the current state of the economy, and (5) the current state of the securities market. The calculation can be complex and is properly the subject of a finance course.
The shares of publicly held companies are traded on organized exchanges. The interaction between buyers and sellers determines the prices per share. In general, the prices set by the marketplace tend to follow the trend of a company’s earnings and dividends. But, factors beyond a company’s control, such as an oil embargo, changes in interest rates, or the outcome of a presidential election, may cause day-to-day fluctuations in market prices.
The trading of ordinary shares on securities exchanges involves the transfer of already issued shares from an existing shareholder to another investor. These transactions have no impact on a corporation’s equity.
Par value shares (sometimes nominal) are ordinary shares to which the charter has assigned a value per share. Years ago, par value determined the legal capital per share that a company must retain in the business for the protection of corporate creditors; that amount was not available for withdrawal by shareholders. Thus, in the past, most governments required the corporation to sell its shares at par or above.
However, par value was often immaterial relative to the value of the company’s shares—even at the time of issue. Thus, its usefulness as a protective device to creditors was questionable. For example, Loews Corporation’s (USA) par value is $0.01 per share, yet a new issue in 2014 would have sold at a market price in the $44 per share range. Thus, par has no relationship with market price. In the vast majority of cases, it is an immaterial amount. As a consequence, today many governments do not require a par value. Instead, they use other means to protect creditors.
No-par value shares are ordinary shares to which the charter has not assigned a value. No-par value shares are fairly common today. For example, Nike (USA) and Anheuser-Busch InBev (BEL) both have no-par shares. In many countries, the board of directors assigns a stated value to no-par shares.
Equity is identified by various names: stockholders’ equity, shareholders’ equity, or corporate capital. The equity section of a corporation’s statement of financial position consists of two parts: (1) share capital and (2) retained earnings (earned capital).
The distinction between share capital and retained earnings is important from both a legal and a financial point of view. Legally, corporations can make distributions of earnings (declare dividends) out of retained earnings in most countries. However, they often cannot declare dividends out of share capital. Management, shareholders, and others often look to retained earnings for the continued existence and growth of the corporation.
Share capital is the total amount of cash and other assets paid in to the corporation by shareholders in exchange for shares. As noted earlier, when a corporation has only one class of shares, they are ordinary shares.
Retained earnings is net income that a corporation retains for future use. Net income is recorded in Retained Earnings by a closing entry that debits Income Summary and credits Retained Earnings. For example, assuming that net income for Delta Robotics in its first year of operations is HK$1,300,000, the closing entry is:
Income Summary | 1,300,000 | |
Retained Earnings | 1,300,000 | |
(To close Income Summary and transfer net income to Retained Earnings) |
If Delta Robotics has a balance of HK$8,000,000 in Share Capital—Ordinary at the end of its first year, its equity section is as follows.
Illustration 11-6 compares the equity accounts reported on a statement of financial position for a proprietorship and a corporation.
A recent survey con-du-cted by Institutional Shareholder Services, a U.S. proxy advisory firm, shows that 83% of investors now believe environmental and social factors can have a significant impact on shareholder value over the long term. This belief is clearly visible in the rising level of support for shareholder proposals requesting action related to social and environmental issues.
The following table shows that the number of corporate social responsibility (CSR)-related shareholder proposals rose from 150 in 2000 to 191 in 2010. Moreover, those proposals garnered average voting support of 18.4% of votes cast versus just 7.5% a decade earlier.
Trends in Shareholder Proposals on Corporate Responsibility | |||
2000 | 2005 | 2010 | |
Number of proposals voted | 150 | 155 | 191 |
Average voting support | 7.5% | 9.9% | 18.4% |
support | 16.7% | 31.2% | 52.1% |
Source: Investor Responsibility Research Center, Ernst & Young, Seven Questions CEOs and Boards Should Ask About: “Triple Bottom Line” Reporting.
Q Why are CSR-related shareholder proposals increasing? (See page 593.)
At the end of its first year of operation, Doral AG has €750,000 of ordinary shares and net income of €122,000. Prepare (a) the closing entry for net income and (b) the equity section at year-end.
Related exercise material: DO IT! 11-2.
Record the issuance of ordinary shares.
Let’s now look at how to account for issues of ordinary shares. The primary objective in accounting for the issuance of ordinary shares is to identify the specific sources of capital.
As discussed earlier, par value does not indicate a share’s market price. Therefore, the cash proceeds from issuing par value shares may be equal to, greater than, or less than par value. When the company records issuance of ordinary shares for cash, it credits the par value of the shares to Share Capital—Ordinary. It records in a separate account the portion of the proceeds that is above or below par value.
To illustrate, assume that Hydro-Slide SA issues 1,000 shares of €1 par value ordinary shares at par for cash. The entry to record this transaction is:
Cash | 1,000 | |
Share Capital—Ordinary | 1,000 | |
(To record issuance of 1,000 €1 par ordinary shares at par) |
Now assume that Hydro-Slide issues an additional 1,000 shares of the €1 par value ordinary shares for cash at €5 per share. The amount received above the par value, in this case , is credited to Share Premium—Ordinary. The entry is:
Cash | 5,000 | |
Share Capital—Ordinary | 1,000 | |
Share Premium—Ordinary | 4,000 | |
(To record issuance of 1,000 €1 par ordinary shares) |
The total capital from these two transactions is €6,000, and the legal capital is €2,000. Assuming Hydro-Slide has retained earnings of €27,000, Illustration 11-7 (page 548) shows the company’s equity section.
When a corporation issues shares for less than par value, it debits the account Share Premium—Ordinary if a credit balance exists in this account. If a credit balance does not exist, then the corporation debits to Retained Earnings the amount less than par. This situation occurs only rarely. Most jurisdictions do not permit the sale of ordinary shares below par value because shareholders may be held personally liable for the difference between the price paid upon original sale and par value.
When no-par ordinary shares have a stated value, the entries are similar to those illustrated for par value shares. The corporation credits the stated value to Share Capital—Ordinary. Also, when the selling price of no-par shares exceeds stated value, the corporation credits the excess to Share Premium—Ordinary.
For example, assume that instead of €1 par value shares, Hydro-Slide SA has €5 stated value no-par shares and the company issues 5,000 shares at €8 per share for cash. The entry is:
Cash | 40,000 | |
Share Capital—Ordinary | 25,000 | |
Share Premium—Ordinary | 15,000 | |
(To record issuance of 5,000 €5 stated value no-par shares) |
Hydro-Slide reports Share Premium—Ordinary below Share Capital—Ordinary in the equity section.
What happens when no-par shares do not have a stated value? In that case, the corporation credits the entire proceeds to Share Capital—Ordinary. Thus, if Hydro-Slide does not assign a stated value to its no-par shares, it records the issuance of the 5,000 shares at €8 per share for cash as follows.
Cash | 40,000 | |
Share Capital—Ordinary | 40,000 | |
(To record issuance of 5,000 no-par shares) |
Corporations also may issue shares for services (compensation to attorneys or consultants) or for non-cash assets (land, buildings, and equipment). In such cases, what cost should be recognized in the exchange transaction? To comply with the historical cost principle, in a non-cash transaction cost is the cash equivalent price. Thus, cost is either the fair value of the consideration given up or the fair value of the consideration received, whichever is more clearly determinable.
To illustrate, assume that attorneys have helped Jordan Company incorporate. They have billed the company €5,000 for their services. They agree to accept 4,000 shares of €1 par value ordinary shares in payment of their bill. At the time of the exchange, there is no established market price for the shares. In this case, the fair value of the consideration received, €5,000, is more clearly evident. Accordingly, Jordan makes the following entry.
Organization Expense | 5,000 | |
Share Capital—Ordinary | 4,000 | |
Share Premium—Ordinary | 1,000 | |
(To record issuance of 4,000 €1 par value shares to attorneys) |
As explained on page 541, organization costs are expensed as incurred.
In contrast, assume that Athletic Research AG is an existing publicly held corporation. Its €5 par value shares are actively traded at €8 per share. The company issues 10,000 shares to acquire land recently advertised for sale at €90,000. The most clearly evident value in this non-cash transaction is the market price of the consideration given, €80,000. The company records the transaction as follows.
Land | 80,000 | |
Share Capital—Ordinary | 50,000 | |
Share Premium—Ordinary | 30,000 | |
(To record issuance of 10,000 €5 par value shares for land) |
As illustrated in these examples, the par value of the shares is never a factor in determining the cost of the assets received. This is also true of the stated value of no-par shares.
ANATOMY OF A FRAUD
The president, chief operating officer, and chief financial officer of SafeNet (USA), a software encryption company, were each awarded employee share options by the company’s board of directors as part of their compensation package. Share options enable an employee to buy a company’s shares sometime in the future at the price that existed when the share option was awarded. For example, suppose that you received share options today, when the share price of your company was $30. Three years later, if the share price rose to $100, you could “exercise” your options and buy the shares for $30 per share, thereby making $70 per share. After being awarded their share options, the three employees changed the award dates in the company’s records to dates in the past, when the company’s shares were trading at historical lows. For instance, using the previous example, they would choose a past date when the shares were selling for $10 per share, rather than the $30 price on the actual award date. This would increase the profit from exercising the options to $90 per share.
Total take: $1.7 million
Independent internal verification. The company’s board of directors should have ensured that the awards were properly administered. For example, the date on the minutes from the board meeting could be compared to the dates that were recorded for the awards. In addition, the dates should again be confirmed upon exercise.
Hefei Ltd. begins operations on March 1 by issuing 1,000,000 ¥10 par value ordinary shares for cash at ¥12 per share. On March 15, it issues 50,000 ordinary shares to attorneys in settlement of their bill of ¥600,000 for organization costs. Journalize the issuance of the shares, assuming the shares are not publicly traded.
Related exercise material: BE11-2, BE11-3, BE11-4, E11-3, E11-4, and DO IT! 11-3.
Explain the accounting for treasury shares.
Treasury shares are a corporation’s own shares that it has issued and subsequently reacquired from shareholders but not retired. A corporation may acquire treasury shares for various reasons:
Another infrequent reason for purchasing shares is that management may want to eliminate hostile shareholders by buying them out.
• HELPFUL HINT
Treasury shares do not have dividend rights or voting rights.
Many corporations have treasury shares. In fact, over 50% of IFRS companies have treasury shares. As examples, adidas (DEU) and Lenovo (CHN) report purchasing treasury shares in recent years.
Companies generally account for treasury shares by the cost method. This method uses the cost of the shares purchased to value the treasury shares. Under the cost method, the company debits Treasury Shares for the price paid to reacquire the shares. When the company disposes of the shares, it credits to Treasury Shares the same amount it paid to reacquire the shares.
To illustrate, assume that on January 1, 2017, the equity section of Mead, Ltd. has 100,000 HK$50 par value ordinary shares outstanding (all issued at par value) and Retained Earnings of HK$2,000,000. The equity section before purchase of treasury shares is as follows.
On February 1, 2017, Mead acquires 4,000 of its shares at HK$80 per share. The entry is:
Feb. 1 | Treasury Shares | 320,000 | |
Cash | 320,000 | ||
(To record purchase of 4,000 treasury shares at HK$80 per share) |
Mead debits Treasury Shares for the cost of the shares purchased. Is the original Share Capital—Ordinary account affected? No, because the number of issued shares does not change. In the equity section of the statement of financial position, Mead deducts treasury shares after retained earnings to determine total equity. Treasury Shares is a contra equity account. Thus, the acquisition of treasury shares reduces equity.
The equity section of Mead after purchase of treasury shares is as follows.
Mead discloses in the statement of financial position both the number of shares issued (100,000) and the number in the treasury (4,000). The difference is the number of shares outstanding (96,000). The term outstanding shares means the number of issued shares that are being held by shareholders.
Some maintain that companies should report treasury shares as an asset because they can be sold for cash. But under this reasoning, companies would also show unissued shares as an asset, which is clearly incorrect. Rather than being an asset, treasury shares reduce shareholder claims on corporate assets. This effect is correctly shown by reporting treasury shares as a deduction from equity.
The purchase of treasury shares reduces the cushion for creditors and preference shareholders. A restriction for the cost of treasury shares purchased is often required. The restriction is usually applied to retained earnings.
In a bold (and some would say risky) move, Reebok (DEU) at one time bought back nearly a third of its shares. This repurchase of shares dramatically reduced Reebok’s available cash. In fact, the company borrowed significant funds to accomplish the repurchase. In a press release, management stated that it was repurchasing the shares because it believed its shares were severely underpriced. The repurchase of so many shares was meant to signal management’s belief in good future earnings.
Skeptics, however, suggested that Reebok’s management was repurchasing shares to make it less likely that another company would acquire Reebok (in which case Reebok’s top managers would likely lose their jobs). By depleting its cash, Reebok became a less likely acquisition target. Acquiring companies like to purchase companies with large cash balances so they can pay off debt used in the acquisition.
As noted in the Feature Story, Reebok was eventually acquired by adidas (DEU). In 2014, adidas announced a program to buy back up to 10% of its shares. This was done to appease shareholders who were disappointed with the company’s results in recent years.
Q What signal might a large share repurchase send to investors regarding management’s belief about the company’s growth opportunities? (See page 594.)
Treasury shares are usually sold or retired. The accounting for their sale differs when treasury shares are sold above cost than when they are sold below cost.
• HELPFUL HINT
Treasury share transactions are classified as equity transactions. As in the case when shares are issued, the income statement is not involved.
SALE OF TREASURY SHARES ABOVE COST If the selling price of the treasury shares is equal to their cost, the company records the sale of the shares by a debit to Cash and a credit to Treasury Shares. When the selling price of the shares is greater than their cost, the company credits the difference to Share Premium—Treasury.
To illustrate, assume that on July 1, Mead, Ltd. sells for HK$100 per share 1,000 of the 4,000 treasury shares previously acquired at HK$80 per share. The entry is as follows.
July 1 | Cash | 100,000 | |
Treasury Shares | 80,000 | ||
Share Premium—Treasury | 20,000 | ||
(To record sale of 1,000 treasury shares above cost) |
Mead does not record a HK$20,000 gain on sale of treasury shares because (1) gains on sales occur when assets are sold, and treasury shares are not an asset, and (2) a corporation does not realize a gain or suffer a loss from share transactions with its own shareholders. Thus, companies should not include in net income any capital arising from the sale of treasury shares. Instead, they report Share Premium—Treasury separately on the statement of financial position, as a part of equity.
SALE OF TREASURY SHARES BELOW COST When a company sells treasury shares below their cost, it usually debits to Share Premium—Treasury the excess of cost over selling price. Thus, if Mead sells an additional 800 treasury shares on October 1 at HK$70 per share, it makes the following entry.
Oct. 1 | Cash | 56,000 | |
Share Premium—Treasury | 8,000 | ||
Treasury Shares | 64,000 | ||
(To record sale of 800 treasury shares below cost) |
Observe the following from the two sales entries. (1) Mead credits Treasury Shares at cost in each entry. (2) Mead uses Share Premium—Treasury for the difference between cost and the resale price of the shares. (3) The original Share Capital—Ordinary account is not affected. The sale of treasury shares increases both total assets and total equity.
After posting the foregoing entries, the treasury share accounts will show the following balances on October 1.
When a company fully depletes the credit balance in Share Premium—Treasury, it debits to Retained Earnings any additional excess of cost over selling price. To illustrate, assume that Mead sells its remaining 2,200 shares at HK$70 per share on December 1. The excess of cost over selling price is . In this case, Mead debits HK$12,000 of the excess to Share Premium—Treasury. It debits the remainder to Retained Earnings. The entry is:
Dec. 1 | Cash | 154,000 | |
Share Premium—Treasury | 12,000 | ||
Retained Earnings | 10,000 | ||
Treasury Shares | 176,000 | ||
(To record sale of 2,200 treasury shares at HK$70 per share) |
Salvador SA purchases 3,000 shares of its R$50 par value ordinary shares for R$180,000 cash on July 1. It will hold the shares in the treasury until resold. On November 1, the corporation sells 1,000 treasury shares for cash at R$70 per share. Journalize the treasury share transactions.
July 1 | Treasury Shares | 180,000 | |
Cash | 180,000 | ||
(To record purchase of 3,000 shares at R$60 per share) | |||
Nov. 1 | Cash | 70,000 | |
Treasury Shares | 60,000 | ||
Share Premium—Treasury | 10,000 | ||
(To record sale of 1,000 shares at R$70 per share) |
Related exercise material: BE11-5, E11-5, and DO IT! 11-4.
Differentiate preference shares from ordinary shares.
To appeal to more investors, a corporation may issue an additional class of shares, called preference shares. Preference shares have contractual provisions that give them some preference or priority over ordinary shares. Typically, preference shareholders have a priority as to (1) distributions of earnings (dividends) and (2) assets in the event of liquidation. However, they sometimes do not have voting rights.
Like ordinary shares, corporations may issue preference shares for cash or for non-cash assets. The entries for these transactions are similar to the entries for ordinary shares. When a corporation has more than one class of shares, each capital account title should identify the shares to which it relates. A company might have the following accounts: Share Capital—Preference, Share Capital—Ordinary, Share Premium—Preference, and Share Premium—Ordinary. For example, if Florence SpA issues 10,000 shares of €10 par value preference shares for €12 cash per share, the entry to record the issuance is:
Cash | 120,000 | |
Share Capital—Preference | 100,000 | |
Share Premium—Preference | 20,000 | |
(To record issuance of 10,000 €10 par value preference shares) |
Preference shares may have either a par value or no-par value. In the equity section of the statement of financial position, companies list preference shares first because of their dividend and liquidation preferences over ordinary shares.
We discuss various features associated with the issuance of preference shares on the following pages.
Preference shareholders have the right to receive dividends before ordinary shareholders. For example, if the dividend rate on preference shares is €5 per share, ordinary shareholders will not receive any dividends in the current year until preference shareholders have received €5 per share. The first claim to dividends does not, however, guarantee the payment of dividends. Dividends depend on many factors, such as adequate retained earnings and availability of cash. If a company does not pay dividends to preference shareholders, it cannot pay dividends to ordinary shareholders.
For preference shares, companies state the per share dividend amount as a percentage of the par value or as a specified amount. For example, Earthlink (USA) specifies a 3% dividend on its $100 par value preference shares. Rostelecom (RUS) specifies preference dividends as the higher of 10% of net income or the dividend paid to ordinary shareholders.
CUMULATIVE DIVIDEND Preference shares often contain a cumulative dividend feature. This feature stipulates that preference shareholders must be paid both current-year dividends and any unpaid prior-year dividends before ordinary shareholders are paid dividends. When preference shares are cumulative, preference dividends not declared in a given period are called dividends in arrears.
To illustrate, assume that Scientific Leasing has 5,000 shares of 7%, €100 par value, cumulative preference shares outstanding. Each €100 share pays a €7 dividend . The annual dividend is . If dividends are two years in arrears, preference shareholders are entitled to receive the dividends shown in Illustration 11-11.
The company cannot pay dividends to ordinary shareholders until it pays the entire preference dividend. In other words, companies cannot pay dividends to ordinary shareholders while any preference dividends are in arrears.
Dividends in arrears are not considered a liability. No payment obligation exists until the board of directors formally declares that the company will pay a dividend. However, companies should disclose in the notes to the financial statements the amount of dividends in arrears. Doing so enables investors to assess the potential impact of this commitment on the corporation’s financial position.
The investment community does not look favorably on companies that are unable to meet their dividend obligations. As a financial officer noted in discussing one company’s failure to pay its cumulative preference dividend for a period of time, “Not meeting your obligations on something like that is a major black mark on your record.”
Most preference shares also have a preference on corporate assets if the corporation fails. This feature provides security for the preference shareholder. The preference to assets may be for the par value of the shares or for a specified liquidating value. The liquidation preference establishes the respective claims of creditors and preference shareholders in litigation involving bankruptcy lawsuits.
Prepare the entries for cash dividends and share dividends.
A dividend is generally a corporation’s distribution of cash or shares to its shareholders on a pro rata (proportional to ownership) basis. Pro rata means that if you own 10% of the ordinary shares, you will receive 10% of the dividend. Dividends can take four forms: cash, property, scrip (a promissory note to pay cash), or shares. Cash dividends predominate in practice although companies also declare share dividends with some frequency. These two forms of dividends are therefore the focus of discussion in this chapter.
Investors are very interested in a company’s dividend practices. In the financial press, dividends are generally reported quarterly on a per share basis. (Sometimes they are reported on an annual basis.) For example, in a recent year, BASF’s (DEU) dividend rate was €1.95 a share, The Hershey Company’s (USA) was $1.19, and Marks and Spencer plc’s (GBR) was 22.5p.
A cash dividend is a pro rata distribution of cash to shareholders. For a corporation to pay a cash dividend, it must have the following.
Retained earnings. The legality of a cash dividend depends on the laws of the state or country in which the company is incorporated. Payment of cash dividends from retained earnings is legal in all jurisdictions. In general, cash dividend distributions from only the balance in share capital—ordinary (legal capital) are illegal.
A dividend declared out of share capital or share premium is termed a liquidating dividend. Such a dividend reduces or “liquidates” the amount originally paid in by shareholders.
Adequate cash. The legality of a dividend and the ability to pay a dividend are two different things. For example, adidas (DEU), with retained earnings of over €5.0 billion, could legally declare a dividend of at least €5.0 billion. But adidas’ cash balance is only €1.6 billion.
Before declaring a cash dividend, a company’s board of directors must carefully consider both current and future demands on the company’s cash resources. In some cases, current liabilities may make a cash dividend inappropriate. In other cases, a major plant expansion program may warrant only a relatively small dividend.
The amount and timing of a dividend are important issues for management to consider. The payment of a large cash dividend could lead to liquidity problems for the company. On the other hand, a small dividend or a missed dividend may cause unhappiness among shareholders. Many shareholders expect to receive a reasonable cash payment from the company on a periodic basis. Many companies declare and pay cash dividends quarterly. On the other hand, a number of high-growth companies pay no dividends, preferring to conserve cash to finance future capital expenditures.
Three dates are important in connection with dividends: (1) the declaration date, (2) the record date, and (3) the payment date. Normally, there are two to four weeks between each date. Companies make accounting entries on the declaration date and the payment date.
On the declaration date, the board of directors formally declares (authorizes) the cash dividend and announces it to shareholders. Declaration of a cash dividend commits the corporation to a legal obligation. The obligation is binding and cannot be rescinded. The company makes an entry to recognize the increase in Cash Dividends and the increase in the liability Dividends Payable.
To illustrate, assume that on December 1, 2017, the directors of Media General declare a €0.50 per share cash dividend on 100,000 €10 par value ordinary shares. The dividend is . The entry to record the declaration is:
Declaration Date | |||
Dec. 1 | Cash Dividends | 50,000 | |
Dividends Payable | 50,000 | ||
(To record declaration of cash dividend) |
Media General debits the account Cash Dividends. Cash dividends decrease retained earnings. We use the specific title Cash Dividends to differentiate it from other types of dividends, such as share dividends. Dividends Payable is a current liability. It will normally be paid within the next several months.
Whichever account is used for the dividend declaration, the effect is the same: Retained Earnings decreases, and a current liability increases. For homework problems, you should use the Cash Dividends account for recording dividend declarations.
• HELPFUL HINT
The purpose of the record date is to identify the persons or entities that will receive the dividend, not to determine the amount of the dividend liability.
At the record date, the company determines ownership of the outstanding shares for dividend purposes. The shareholders’ records maintained by the corporation supply this information. In the interval between the declaration date and the record date, the corporation updates its share ownership records. For Media General, the record date is December 22. No entry is required on this date because the corporation’s liability recognized on the declaration date is unchanged.
Record Date | |||
Dec. 22 | No entry |
On the payment date, the company makes cash dividend payments to the shareholders of record (as of December 22) and records the payment of the dividend. If January 20 is the payment date for Media General, the entry on that date is as follows.
Payment Date | |||
Jan. 20 | Dividends Payable | 50,000 | |
Cash | 50,000 | ||
(To record payment of cash dividend) |
Note that payment of the dividend reduces both current assets and current liabilities. It has no effect on equity. The cumulative effect of the declaration and payment of a cash dividend is to decrease both equity and total assets. Illustration 11-2 summarizes the three important dates associated with dividends for Media General.
When using a Cash Dividends account, Media General should transfer the balance of that account to Retained Earnings at the end of the year by a closing entry. The entry for Media General at closing is as follows.
Retained Earnings | 50,000 | |
Cash Dividends | 50,000 | |
(To close Cash Dividends to Retained Earnings) |
As indicated, preference shares have priority over ordinary shares in regard to dividends. Holders of cumulative preference shares must be paid any unpaid prior-year dividends and their current year’s dividend before ordinary shareholders receive dividends.
To illustrate, assume that at December 31, 2017, IBR SE has 1,000 shares of 8%, €100 par value cumulative preference shares. It also has 50,000 €10 par value ordinary shares outstanding. The dividend per share for preference shares is . The required annual dividend for preference shares is therefore . At December 31, 2017, the directors declare a €6,000 cash dividend. In this case, the entire dividend amount goes to preference shareholders because of their dividend preference. The entry to record the declaration of the dividend is:
Dec. 31 | Cash Dividends | 6,000 | |
Dividends Payable | 6,000 | ||
(To record €6 per share cash dividend to preference shareholders) |
Because of the cumulative feature, dividends of per share are in arrears on preference shares for 2017. IBR must pay these dividends to preference shareholders before it can pay any future dividends to ordinary shareholders. IBR should disclose dividends in arrears in the financial statements.
At December 31, 2018, IBR declares a €50,000 cash dividend. The allocation of the dividend to the two classes of shares is as follows.
The entry to record the declaration of the dividend is as follows.
Dec. 31 | Cash Dividends | 50,000 | |
Dividends Payable | 50,000 | ||
(To record declaration of cash dividends of €10,000 to preference shares and €40,000 to ordinary shares) |
If IBR’s preference shares are not cumulative, preference shareholders receive only €8,000 in dividends in 2018. Ordinary shareholders receive €42,000.
MasterMind SA has 2,000 shares of 6%, €100 par value preference shares outstanding at December 31, 2017. At December 31, 2017, the company declared a €60,000 cash dividend. Determine the dividend paid to preference shareholders and ordinary shareholders under each of the following scenarios.
Related exercise material: E11-6 and DO IT! 11-5.
A share dividend is a pro rata distribution to shareholders of the corporation’s own shares. Whereas a company pays cash in a cash dividend, a company issues shares in a share dividend. A share dividend results in a decrease in retained earnings and an increase in share capital and share premium. Unlike a cash dividend, a share dividend does not decrease total equity or total assets.
To illustrate, assume that you have a 2% ownership interest in Cetus Ltd.; you own 20 of its 1,000 ordinary shares. If Cetus declares a 10% share dividend, it would issue 100 shares . You would receive two shares . Would your ownership interest change? No, it would remain at 2% . You now own more shares, but your ownership interest has not changed. Illustration 11-14 shows the effect of a share dividend for shareholders.
Cetus has disbursed no cash and has assumed no liabilities. What, then, are the purposes and benefits of a share dividend? Corporations issue share dividends generally for one or more of the following reasons.
When the dividend is declared, the board of directors determines the size of the share dividend and the value assigned to each dividend.
IFRS is silent regarding the accounting for share dividends. One approach used in some countries is that if the company issues a small share dividend (less than 20–25% of the corporation’s issued shares), the value assigned to the dividend is the fair value (market price) per share. This treatment is based on the assumption that a small share dividend will have little effect on the market price of the shares previously outstanding. Thus, many shareholders consider small share dividends to be distributions of earnings equal to the fair value of the shares distributed. If a company issues a large share dividend (greater than 20–25%), the value assigned to the dividend is the par or stated value. Small share dividends predominate in practice. Thus, we will illustrate only entries for small share dividends.
To illustrate the accounting for small share dividends, assume that Danshui Ltd. has a balance of NT$3,000,000 in retained earnings. It declares a 10% share dividend on its 50,000 shares of NT$100 par value ordinary shares. The current fair value of its shares is NT$150 per share. The number of shares to be issued is . Therefore, the total amount to be debited to Share Dividends is . The entry to record the declaration of the share dividend is as follows.
Share Dividends | 750,000 | |
Ordinary Share Dividends Distributable | 500,000 | |
Share Premium—Ordinary | 250,000 | |
(To record declaration of 10% share dividend) |
Danshui debits Share Dividends for the fair value of the shares issued . (Similar to Cash Dividends, Share Dividends decrease retained earnings.) Danshui also credits Ordinary Share Dividends Distributable for the par value of the dividend shares and credits Share Premium—Ordinary for the excess over par .
Ordinary Share Dividends Distributable is an equity account. It is not a liability because assets will not be used to pay the dividend. If the company prepares a statement of financial position before it issues the dividend shares, it reports the distributable account as shown in Illustration 11-15.
When Danshui issues the dividend shares, it debits Ordinary Share Dividends Distributable and credits Share Capital—Ordinary, as follows.
Ordinary Share Dividends Distributable | 500,000 | |
Share Capital—Ordinary | 500,000 | |
(To record issuance of 5,000 shares in a share dividend) |
How do share dividends affect equity? They change the composition of equity because they transfer a portion of retained earnings to share capital and share premium. However, total equity remains the same. Share dividends also have no effect on the par or stated value per share, but the number of shares outstanding increases. Illustration 11-16 shows these effects for Danshui Ltd.
In this example, the total of share capital—ordinary and share premium—ordinary increases by and retained earnings decreases by the same amount. Note also that total equity remains unchanged at NT$8,000,000. The number of shares increases by .
A share split, like a share dividend, involves issuance of additional shares to shareholders according to their percentage ownership. However, a share split results in a reduction in the par or stated value per share. The purpose of a share split is to increase the marketability of the shares by lowering the market price per share. This, in turn, makes it easier for the corporation to issue additional shares.
The effect of a split on market price is generally inversely proportional to the size of the split. For example, after a 2-for-1 share split, the market price of Nike’s (USA) shares fell from $111 to approximately $55. The lower market price stimulated market activity, and within one year the shares were trading above $100 again.
In a share split, the company increases the number of shares in the same proportion that par or stated value per share decreases. For example, in a 2-for-1 split, the company exchanges one $10 par value share for two $5 par value shares. A share split does not have any effect on share capital, share premium, retained earnings, or total equity. However, the number of shares outstanding increases, and par value per share decreases. Illustration 11-17 shows these effects for Danshui Ltd., assuming that it splits its 50,000 ordinary shares on a 2-for-1 basis.
A share split does not affect the balances in any equity accounts. Therefore, a company does not need to journalize a share split.
• HELPFUL HINT
A share split changes the par value per share but does not affect any balances in equity.
Illustration 11-18 summarizes the differences between share dividends and share splits.
Warren Buffett’s company, Berkshire Hathaway (USA), has two classes of shares. Until recently, the company had never split either class of shares. As a result, the class A shares had a market price of $97,000 and the class B sold for about $3,200 per share. Because the price per share is so high, the shares do not trade as frequently as the shares of other companies. Mr. Buffett has always opposed share splits because he feels that a lower share price attracts short-term investors. He appears to be correct. For example, while more than 6 million shares of IBM (USA) are exchanged on the average day, only about 1,000 class A shares of Berkshire are traded. Despite Mr. Buffett’s aversion to splits, in order to accomplish a recent acquisition, Berkshire decided to split its class B shares 50 to 1.
Source: Scott Patterson, “Berkshire Nears Smaller Baby B’s,” Wall Street Journal Online (January 19, 2010).
Q Why does Warren Buffett usually oppose share splits? (See page 594.)
Sing CD Company has had five years of record earnings. Due to this success, the market price of its 500,000 shares of £2 par value ordinary shares has tripled from £15 per share to £45. During this period, the sum of share capital and share premium remained the same at £2,000,000. Retained earnings increased from £1,500,000 to £10,000,000. CEO Joan Elbert is considering either a 10% share dividend or a 2-for-1 share split. She asks you to show the before-and-after effects of each option on retained earnings, total equity, total shares outstanding, and par value per share.
The share dividend amount is . The new balance in retained earnings is . The retained earnings balance after the share split is the same as it was before the split: £10,000,000. Total equity does not change. The effects on the equity accounts are as follows.
Original Balances | After Dividend | After Split | |
Share capital/premium | £ 2,000,000 | £ 4,250,000 | £ 2,000,000 |
Retained earnings | 10,000,000 | 7,750,000 | 10,000,000 |
Total equity | £12,000,000 | £12,000,000 | £12,000,000 |
Shares outstanding | 500,000 | 550,000 | 1,000,000 |
Par value per share | £2 | £2 | £1 |
Related exercise material: BE11-8, BE11-9, E11-14, E11-15, E11-16, and DO IT! 11-6.
Identify the items reported in a retained earnings statement.
Recall that retained earnings is net income that a company retains in the business. The balance in retained earnings is part of the shareholders’ claim on the total assets of the corporation. It does not, though, represent a claim on any specific asset. Nor can the amount of retained earnings be associated with the balance of any asset account. For example, a NT$10,000,000 balance in retained earnings does not mean that there should be NT$10,000,000 in cash. The reason is that the company may have used the cash resulting from the excess of revenues over expenses to purchase buildings, equipment, and other assets.
To demonstrate that retained earnings and cash may be quite different, Illustration 11-19 shows recent amounts of retained earnings and cash in selected companies.
Remember that when a company has net income, it closes net income to retained earnings. The closing entry is a debit to Income Summary and a credit to Retained Earnings.
• HELPFUL HINT
Remember that Retained Earnings is an equity account, whose normal balance is a credit.
When a company has a net loss (expenses exceed revenues), it also closes this amount to retained earnings. The closing entry in this case is a debit to Retained Earnings and a credit to Income Summary. To illustrate, assume that Rendle Corporation has a net loss of $400,000 in 2017. The closing entry to record this loss is as follows.
Retained Earnings | 400,000 | |
Income Summary | 400,000 | |
(To close net loss to Retained Earnings) |
This closing entry is done even if it results in a debit balance in Retained Earnings. Companies do not debit net losses to share capital or share premium. If cumulative losses exceed cumulative income over a company’s life, a debit balance in Retained Earnings results. A debit balance in Retained Earnings is identified as a deficit. A company reports a deficit as a deduction in the equity section, as shown below.
The balance in retained earnings is generally available for dividend declarations. In some cases, however, there may be retained earnings restrictions. These make a portion of the retained earnings balance currently unavailable for dividends. Restrictions result from one or more of the following causes.
Companies generally disclose retained earnings restrictions in the notes to the financial statements. For example, as shown in Illustration 11-21, Tektronix Inc. (USA), a manufacturer of electronic measurement devices, had total retained earnings of $774 million, but the unrestricted portion was only $223.8 million.
Suppose that a company has closed its books and issued financial statements. The company then discovers that it made a material error in reporting net income of a prior year. How should the company record this situation in the accounts and report it in the financial statements?
The correction of an error in previously issued financial statements is known as a prior period adjustment. The company makes the correction directly to Retained Earnings because the effect of the error is now in this account. The net income for the prior period has been recorded in retained earnings through the journalizing and posting of closing entries.
To illustrate, assume that General Microwave AG discovers in 2017 that it understated depreciation expense on equipment in 2016 by £300,000 due to computational errors. These errors overstated both net income for 2016 and the current balance in retained earnings. The entry for the prior period adjustment, ignoring all tax effects, is as follows.
Retained Earnings | 300,000 | |
Accumulated Depreciation—Equipment | 300,000 | |
(To adjust for understatement of depreciation in a prior period) |
A debit to an income statement account in 2017 is incorrect because the error pertains to a prior year.
Companies report prior period adjustments in the retained earnings statement. They add (or deduct, as the case may be) these adjustments from the beginning retained earnings balance. This results in an adjusted beginning balance. For example, assuming a beginning balance of £800,000 in retained earnings, General Microwave reports the prior period adjustment as follows.
Again, reporting the correction in the current year’s income statement would be incorrect because it applies to a prior year’s income statement.
The retained earnings statement shows the changes in retained earnings during the year. The company prepares the statement from the Retained Earnings account. Illustration 11-23 shows (in T-account form) transactions that affect retained earnings.
As indicated, net income increases retained earnings, and a net loss decreases retained earnings. Prior period adjustments may either increase or decrease retained earnings. Both cash dividends and share dividends decrease retained earnings. The circumstances under which treasury share transactions decrease retained earnings are explained on page 552.
A complete retained earnings statement for Graber SA, based on assumed data, is as follows.
Chen Ltd. has retained earnings of ¥5,130,000 on January 1, 2017. During the year, Chen earned ¥2,000,000 of net income. It declared and paid a ¥250,000 cash dividend. In 2017, Chen recorded an adjustment of ¥180,000 due to the understatement (from a mathematical error) of 2016 depreciation expense. Prepare a retained earnings statement for 2017.
Related exercise material: BE11-10, BE11-11, E11-17, E11-18, and DO IT! 11-7.
Prepare and analyze a comprehensive equity section.
The equity section of the statement of financial position reports share capital, share premium, and retained earnings.
Illustration 11-25 presents the equity section of Graber SA’s statement of financial position. Note the following: (1) “Ordinary share dividends distributable” is shown under “Share capital—ordinary” and (2) A note (Note R) discloses a retained earnings restriction.
The equity section of Graber SA in Illustration 11-25 includes most of the accounts discussed in this chapter. The disclosures pertaining to Graber’s ordinary shares indicate that the company issued 400,000 shares; 100,000 shares are unissued (500,000 authorized less 400,000 issued); and 390,000 shares are outstanding (400,000 issued less 10,000 shares in treasury).
Published annual reports often combine and report as a single amount the individual sources of share premium, as shown in Illustration 11-26. In addition, authorized shares are sometimes not reported. Finally, notice the line labeled “Reserves.”
Under IFRS, companies often use the term “Reserves” for forms of equity other than that contributed by shareholders. Reserves sometimes includes retained earnings. More commonly, this line item is used to report the equity impact of comprehensive income items, such as the Revaluation Surplus that resulted from the revaluation of property, plant, and equipment in Chapter 9.
Instead of presenting a detailed equity section in the statement of financial position and a retained earnings statement, many companies prepare a statement of changes in equity. This statement shows the changes (1) in each equity account and (2) in total that occurred during the year. An example of an equity statement is illustrated in an appendix to this chapter (see Illustration 11-26).
Investors and analysts can measure profitability from the viewpoint of the investor in ordinary shares by the return on ordinary shareholders’ equity. This ratio, as shown below for Carrefour (FRA), indicates how many euros of net income the company earned for each euro invested by the ordinary shareholders. It is computed by dividing net income available to ordinary shareholders (which is net income minus preference dividends) by average ordinary shareholders’ equity.
Carrefour’s beginning-of-the-year and end-of-the-year ordinary shareholders’ equity were €8,047 and €8,597 million, respectively. Its net income was €1,263 million, and no preference shares were outstanding. The return on ordinary shareholders’ equity is computed as follows.
As shown above, if a company has preference shares, we deduct the amount of preference dividends from the company’s net income to compute income available to ordinary shareholders. Also, the par value of preference shares is deducted from total average shareholders’ equity to arrive at the amount of ordinary shareholders’ equity.
On January 1, 2017, Busan Ltd. purchased 2,000,000 treasury shares. Other information regarding Busan is provided below. (All amounts in thousands.)
2016 | 2017 | |
Net income | 110,000 | 110,000 |
Dividends on preference shares | 10,000 | 10,000 |
Dividends on ordinary shares | 2,000 | 1,600 |
Ordinary shareholders’ equity, beginning of year | 500,000 | 400,000* |
Ordinary shareholders’ equity, end of year | 500,000 | 400,000 |
Adjusted for purchase of treasury shares.
Compute (a) return on ordinary shareholders’ equity for each year and (b) discuss the changes from 2016 to 2017.
(All amounts in thousands.)
Related exercise material: E11-22 and DO IT! 11-8.
Describe the use and content of the statement of changes in equity.
When statements of financial position and income statements are presented by a corporation, changes in the separate accounts comprising equity should also be disclosed. Disclosure of such changes is necessary to make the financial statements sufficiently informative for users. The disclosures are made in an additional statement called the statement of changes in equity. The statement shows the changes in each equity account and in total equity during the year. As shown in Illustration 11-26, the statement is prepared in columnar form. It contains columns for each account and for total equity. The transactions are then identified and their effects are shown in the appropriate columns.
In practice, additional columns are usually provided to show the number of shares of issued shares and treasury shares. When a statement of changes in equity is presented, a retained earnings statement is not necessary because the retained earnings column explains the changes in this account.
Compute book value per share.
You have learned about a number of per share amounts in this chapter. Another per share amount of some importance is book value per share. It represents the equity an ordinary shareholder has in the net assets of the corporation from owning one share. Remember that the net assets (total assets minus total liabilities) of a corporation must be equal to total equity. Therefore, the formula for computing book value per share when a company has only one class of shares outstanding is as follows.
Thus, if Marlo Corporation has total ordinary shareholders’ equity of $1,500,000 (share capital—ordinary $1,000,000 and retained earnings $500,000) and 50,000 shares of ordinary shares outstanding, book value per share is .
When a company has both preference and ordinary shares, the computation of book value is more complex. Since preference shareholders have a prior claim on net assets over ordinary shareholders, their equity must be deducted from total equity. Then we can determine the equity that applies to the ordinary shares. The computation of book value per share involves the following steps.
We will use the equity section of Graber SA shown in Illustration 11-25. Graber’s preference shares are callable at €120 per share and are cumulative. Assume that dividends on Graber’s preference shares were in arrears for one year, . The computation of preference share equity (Step 1 in the preceding list) is shown below.
The computation of book value (Steps 2 and 3) is as follows.
Note that we used the call price of €120 instead of the par value of €100. Note also that share premium—preference, €30,000, is not assigned to the preference share equity. Preference shareholders ordinarily do not have a right to amounts contributed in excess of par value. Therefore, such amounts are assigned to the ordinary shareholders’ equity in computing book value.
Be sure you understand that book value per share may not equal market price per share. Book value generally is based on recorded costs. Market price reflects the subjective judgments of thousands of shareholders and prospective investors about a company’s potential for future earnings and dividends. Market price per share may exceed book value per share, but that fact does not necessarily mean that the shares are overpriced. The correlation between book value and the annual range of a company’s market price per share is often remote, as indicated by the following recent data for some U.S. companies.
Book value per share is useful in determining the trend of a shareholder’s per share equity in a corporation. It is also significant in many contracts and in court cases where the rights of individual parties are based on cost information.
Corporations must disclose changes in equity accounts and may choose to do so by issuing a separate equity statement. This statement, prepared in columnar form, shows changes in each equity account and in total equity during the accounting period. When this statement is presented, a retained earnings statement is not necessary.
Book value per share represents the equity an ordinary shareholder has in the net assets of a corporation from owning one share. When there are only ordinary shares outstanding, the formula for computing book value is .
Separate legal existence.
Continuous life.
Government regulations.
Transferable ownership rights.
A major disadvantage of a corporation is:
limited liability of shareholders.
additional taxes.
transferable ownership rights.
separate legal existence.
Which of the following statements is false?
Ownership of ordinary shares gives the owner a voting right.
The equity section begins with a share capital section.
The authorization of share capital does not result in a formal accounting entry.
Par value and market price of a company’s shares are always the same.
ABC Industries Ltd. issues 1,000 €10 par ordinary shares value at €12 per share. In recording the transaction, credits are made to:
Share Capital—Ordinary €10,000 and Share Premium—Ordinary €2,000.
Share Capital—Ordinary €12,000.
Share Capital—Ordinary €10,000 and Gain from Sale of Shares €2,000.
Share Capital—Ordinary €10,000 and Retained Earnings €2,000.
XYZ, Ltd. sells 100 of its £5 par value treasury shares at £13 per share. If the cost of acquiring the shares was £10 per share, the entry for the sale should include credits to:
Treasury Shares 1,000 and Share Premium—Treasury 300.
Treasury Shares 500 and Share Premium—Treasury 800.
Treasury Shares 1,000 and Retained Earnings 300.
Treasury Shares 500 and Gain from Sale of Treasury Shares 800.
In the statement of financial position, the cost of treasury shares is deducted in:
expenses.
revenues.
equity.
liabilities.
Preference shares may have priority over ordinary shares except in:
dividends.
assets in the event of liquidation.
cumulative dividend features.
voting.
M-Bot Enterprises has 10,000 8%, £100 par value, cumulative preference shares outstanding at December 31, 2017. No dividends were declared in 2015 or 2016. If M-Bot wants to pay £375,000 of dividends in 2017, ordinary shareholders will receive:
£0.
£295,000.
£215,000.
£135,000.
declaration date and the payment date.
record date and the payment date.
declaration date, record date, and payment date.
declaration date and the record date.
Which of the following statements about small share dividends is true?
A debit to Retained Earnings for the par value of the shares issued should be made.
A small share dividend decreases total equity.
Market price per share should be assigned to the dividend shares.
A small share dividend ordinarily will have an effect on par value per share.
All but one of the following is reported in a retained earnings statement. The exception is:
cash and share dividends.
net income and net loss.
sales revenue.
prior period adjustments.
A prior period adjustment is:
reported in the income statement as a non--typical item.
a correction of an error that is recorded directly to retained earnings.
reported directly in the equity section of the statement of financial position.
reported in the retained earnings statement as an adjustment of the ending balance of retained earnings.
In the equity section of the statement of financial position, share capital—ordinary:
is listed before share capital—preference.
is listed after retained earnings.
is listed after share capital—preference.
is reduced for treasury shares.
Adana A.Ş. reported net income of 186,000 during 2017, paid dividends of 26,000 on ordinary shares, and paid dividends of 60,000 on preference shares. It also has 10,000 shares of 6%, 100 par value, non-cumulative preference shares outstanding. Ordinary shareholders’ equity was 1,200,000 on January 1, 2017, and 1,600,000 on December 31, 2017. The company’s return on ordinary shareholders’ equity for 2017 is:
10.0%.
9.0%.
7.1%.
13.3%.
*When a statement of changes in equity is presented, it is not necessary to prepare a (an):
retained earnings statement.
statement of financial position.
income statement.
statement of cash flows.
The ledger of JFK, plc shows share capital—ordinary, treasury shares—ordinary, and no preference shares. For this company, the formula for computing book value per share is:
total equity divided by the number of ordinary shares issued.
share capital—ordinary divided by the number of ordinary shares issued.
total equity divided by the number of ordinary shares outstanding.
share capital—ordinary divided by the number of ordinary shares outstanding.
Journalize issuance of ordinary and preference shares and purchase of treasury shares.
Mar. | 2 | Issued 5,000 shares of £5 par value ordinary shares to attorneys in payment of a bill for £35,000 for services performed in helping the company to incorporate. |
June | 12 | Issued 60,000 shares of £5 par value ordinary shares for cash of £370,000. |
July | 11 | Issued 1,000 shares of £100 par value preference shares for cash at £112 per share. |
Nov. | 28 | Purchased 2,000 shares of treasury shares for £70,000. |
Journalize the transactions.
Mar. | 2 | Organization Expense | 35,000 | |
Share Capital—Ordinary | 25,000 | |||
Share Premium—Ordinary | 10,000 | |||
June | 12 | Cash | 370,000 | |
Share Capital—Ordinary | 300,000 | |||
Share Premium—Ordinary | 70,000 | |||
July | 11 | Cash | 112,000 | |
Share Capital—Preference | 100,000 | |||
Share Premium—Preference | 12,000 | |||
Nov. | 28 | Treasury Shares | 70,000 | |
Cash | 70,000 |
Journalize cash dividends; indicate statement presentation.
Apr. | 1 | Issued 25,000 additional ordinary shares for NT$170 per share. |
June | 15 | Declared a cash dividend of NT$10 per share to shareholders of record on June 30. |
July | 10 | Paid the NT$10 cash dividend. |
Dec. | 1 | Issued 2,000 additional ordinary shares for NT$190 per share. |
15 | Declared a cash dividend on outstanding shares of NT$12 per share to shareholders of record on December 31. |
Prepare the entries, if any, on each of the three dividend dates.
How are dividends and dividends payable reported in the financial statements prepared at December 31?
Prepare a retained earnings statement.
Prepare a retained earnings statement for the year ended December 31, 2017.
Journalize transactions and prepare equity section.
Cabral SA is authorized to issue 1,000,000 R$5 par value ordinary shares. In its first year, the company has the following share transactions.
Jan. | 10 | Issued 400,000 ordinary shares at R$8 per share. |
July | 1 | Issued 100,000 ordinary shares for land. The land had an asking price of R$900,000. The shares are currently selling on a national exchange at R$8.25 per share. |
Sept. | 1 | Purchased 10,000 ordinary shares for the treasury at R$9 per share. |
Dec. | 1 | Sold 4,000 treasury shares at R$10 per share. |
Journalize the transactions.
Prepare the equity section assuming the company had retained earnings of R$200,000 at December 31.
Brief Exercises, DO IT! Review, Exercises, and Problems, and many additional resources are available for practice in WileyPLUS.
NOTE: Asterisked Questions, Exercises, and Problems relate to material in the appendices to the chapter.
Mark Adler, a student, asks your help in understanding the following characteristics of a corporation: (a) separate legal existence, (b) limited liability of shareholders, and (c) transferable ownership rights. Explain these characteristics to Mark.
Your friend Paula Leuck cannot understand how the characteristic of corporation management is both an advantage and a disadvantage. Clarify this problem for Paula.
Identify and explain two other disadvantages of a corporation.
The following terms pertain to the forming of a corporation: (1) charter, (2) by-laws, and (3) organization costs. Explain the terms.
What are the basic ownership rights of ordinary shareholders in the absence of restrictive provisions?
A corporation has been defined as an entity separate and distinct from its owners. In what ways is a corporation a separate legal entity?
What are the two principal components of equity?
What is share capital? Give three examples.
The corporate charter of Keller Ltd. allows the issuance of a maximum of 100,000 ordinary shares. During its first two years of operations, Keller sold 70,000 shares and reacquired 7,000 of these shares. After these transactions, how many shares are authorized, issued, and outstanding?
Which is the better investment—ordinary shares with a par value of 5,000 per share, or ordinary shares with a par value of 20,000 per share? Why?
What factors help determine the market price of shares?
Why are ordinary shares usually not issued at a price that is less than par value?
Land appraised at £84,000 is purchased by issuing 1,000 £10 par value ordinary shares. The market price of the shares at the time of the exchange, based on active trading in the securities market, is £95 per share. Should the land be recorded at £10,000, £84,000, or £95,000? Explain.
For what reasons might a company like IBM (USA) repurchase some of its shares (treasury shares)?
Luz, A/S purchases 1,000 shares of its own previously issued €5 par value ordinary shares for €9,000. Assuming the shares are held in the treasury, what effect does this transaction have on (a) net income, (b) total assets, (c) retained earnings, and (d) total equity?
The treasury shares purchased in Question 13 are resold by Luz, A/S for €13,000. What effect does this transaction have on (a) net income, (b) total assets, (c) retained earnings, and (d) total equity?
What are the principal differences between ordinary shares and preference shares?
Preference shares may be cumulative. Discuss this feature.
How are dividends in arrears presented in the financial statements?
Identify the events that result in credits and debits to retained earnings.
Tim Miotke maintains that adequate cash is the only requirement for the declaration of a cash dividend. Is Tim correct? Explain.
Three dates are important in connection with cash dividends. Identify these dates, and explain their significance to the corporation and its shareholders.
Identify the accounting entries that are made for a cash dividend and the date of each entry.
Contrast the effects of a cash dividend and a share dividend on a corporation’s statement of financial position.
Travis Plum asks, “Since share dividends don’t change anything, why declare them?” What is your answer to Travis?
Meloy Company Ltd. has 30,000 £9 par value ordinary shares outstanding when it announces a 3-for-1 share split. Before the split, the shares had a market price of £120 per share. After the split, how many shares will be outstanding? What will be the approximate market price per share?
The board of directors is considering either a share split or a share dividend. They understand that total equity will remain the same under either action. However, they are not sure of the different effects of the two types of actions on other aspects of equity. Explain the differences to the directors.
What is a prior period adjustment, and how is it reported in the financial statements?
What is the purpose of a retained earnings restriction? Identify the possible causes of retained earnings restrictions.
What is the formula for computing book value per share when a corporation has only ordinary shares?
Bihar Ltd.’s ordinary shares have a par value of Rs10, a book value of Rs240, and a current market price of Rs180. Explain why these amounts are all different.
List the advantages and disadvantages of a corporation.
BE11-1 Kari Home is studying for her accounting midterm examination. Identify for Kari the advantages and disadvantages of the corporate form of business organization.
Prepare entries for issuance of par value ordinary shares.
BE11-2 On May 10, Chen Co. issues 2,000 €6 par value ordinary shares for cash at €13 per share. Journalize the issuance of the shares.
Prepare entries for issuance of no-par value ordinary shares.
BE11-3 On June 1, Federia Ltd. issues 4,500 no-par ordinary shares at a cash price of ¥6 per share. Journalize the issuance of the shares assuming the shares have a stated value of ¥2 per share.
Prepare entries for issuance of shares in a non-cash transaction.
BE11-4 Alou Ltd.’s £10 par value ordinary shares are actively traded at a market price of £15 per share. Alou issues 5,000 shares to purchase land advertised for sale at £81,000. Journalize the issuance of the shares in acquiring the land.
Prepare entries for treasury share transactions.
BE11-5 On July 1, Pearl River Industries purchases 500 of its HK$20 par value ordinary shares for the treasury at a cash price of HK$80 per share. On September 1, it sells 350 treasury shares for cash at HK$90 per share. Journalize the two treasury share transactions.
Prepare entries for issuance of preference shares.
BE11-6 Chard Ltd. issues 5,000 £100 par value preference shares for cash at £118 per share. Journalize the issuance of the preference shares.
Prepare entries for a cash dividend.
BE11-7 Fields Enterprises has 70,000 ordinary shares outstanding. It declares a €1.5 per share cash dividend on November 1 to shareholders of record on December 1. The dividend is paid on December 31. Prepare the entries on the appropriate dates to record the declaration and payment of the cash dividend.
Prepare entries for a share dividend.
BE11-8 Valiant Ltd. has 56,000 £10 par value ordinary shares outstanding. It declares a 10% share dividend on December 1 when the market price per share is £16. The dividend shares are issued on December 31. Prepare the entries for the declaration and payment of the share dividend.
Show before-and-after effects of a share dividend.
BE11-9 The equity section of Neely Company Ltd. consists of share capital—ordinary (£10 par) £2,000,000 and retained earnings £500,000. A 15% share dividend (30,000 shares) is declared when the market price per share is £16. Show the before-and-after effects of the dividend on the following.
The components of equity.
Shares outstanding.
Par value per share.
Prepare a retained earnings statement.
BE11-10 For the year ending December 31, 2017, Abbott SE reports net income €140,000 and dividends €55,000. Prepare the retained earnings statement for the year assuming the balance in retained earnings on January 1, 2017, was €220,000.
Prepare a retained earnings statement.
BE11-11 The balance in retained earnings on January 1, 2017, for Sandra Ltd. was £800,000. During the year, the corporation paid cash dividends of £50,000 and distributed a share dividend of £8,000. In addition, the company determined that it had understated its depreciation expense in prior years by £35,000. Net income for 2017 was £120,000. Prepare the retained earnings statement for 2017.
Prepare equity section.
BE11-12 Garcia Enterprises SLU has the following accounts at December 31: Share Capital—Ordinary, €10 par, 5,000 shares issued, €50,000; Share Premium—Ordinary €32,000; Retained Earnings €45,000; and Treasury Shares, 500 shares, €9,000. Prepare the equity section of the statement of financial position.
Compute book value per share.
*BE11-13 The statement of financial position for Lauren Ltd. shows the following: total equity £817,000, ordinary shares issued 44,000 shares, and ordinary shares outstanding 35,000 shares. Compute the book value per share. (No preference shares are outstanding.)
Analyze statements about corporate organization.
DO IT! 11-1 Indicate whether each of the following statements is true or false. If false, indicate how to correct the statement.
Close net income and prepare equity section.
DO IT! 11-2 At the end of its first year of operation, Jaeger Industries AG has €1,000,000 of ordinary shares and net income of €228,000. Prepare (a) the closing entry for net income and (b) the equity section at year-end.
Journalize issuance of shares.
DO IT! 11-3 Zermatt AG began operations on April 1 by issuing 50,000 CHF2 par value ordinary shares for cash at CHF13 per share. On April 19, it issued 2,000 ordinary shares to attorneys in settlement of their bill of CHF27,100 for organization costs. Journalize both issuances, assuming the shares are not publicly traded.
Journalize treasury share transactions.
DO IT! 11-4 Delsman Limited purchased 2,000 of its £5 par value ordinary shares for £128,000 on August 1. It will hold these shares in the treasury until resold. On December 1, the corporation sold 1,200 treasury shares for cash at £72 per share. Journalize the treasury share transactions.
Determine dividends paid to preference and ordinary shareholders.
DO IT! 11-5 Inmann SE has 2,000 7%, €100 par value preference shares outstanding at December 31, 2017. At December 31, 2017, the company declared a €110,000 cash dividend. Determine the dividend paid to preference shareholders and ordinary shareholders under each of the following scenarios.
Determine effects of share dividend and share split.
DO IT! 11-6 Sentry Company Ltd. has had 4 years of strong earnings. Due to this success, the market price of its 400,000 £2 par value ordinary shares has increased from £12 per share to £49. During this period, share capital and share premium remained the same at a total of £2,400,000. Retained earnings increased from £1,800,000 to £12,000,000. CEO T. Boldt is considering either a 15% share dividend or a 2-for-1 share split. He asks you to show the before-and-after effects of each option on (a) retained earnings, (b) total equity, and (c) outstanding shares and par value per share.
Prepare a retained earnings statement.
DO IT! 11-7 Raymond SA has retained earnings of €3,100,000 on January 1, 2017. During the year, Raymond earned €1,200,000 of net income. It declared and paid a €130,000 cash dividend. In 2017, Raymond recorded an adjustment of €75,000 due to the overstatement (from mathematical error) of 2016 depreciation expense. Prepare a retained earnings statement for 2017.
Compute return on equity.
DO IT! 11-8 On January 1, 2017, Leonard Industries purchased 1,000 treasury shares. Other information regarding Leonard Industries is provided below.
2016 | 2017 | |
Net income | £200,000 | £210,000 |
Dividends on preference shares | £30,000 | £30,000 |
Dividends on ordinary shares | £20,000 | £25,000 |
Weighted-average number of ordinary shares outstanding | 10,000 | 9,000 |
Ordinary shareholders’ equity beginning of year | £600,000 | £760,000 |
Ordinary shareholders’ equity end of year | £760,000 | £830,000 |
Compute return on ordinary shareholders’ equity for each year.
Identify characteristics of a corporation.
E11-1 Victoria has prepared the following list of statements about corporations.
Instructions
Identify each statement as true or false. If false, indicate how to correct the statement.
Identify characteristics of a corporation.
E11-2 Victoria (see E11-1) has studied the information you gave her in that exercise and has come to you with more statements about corporations.
Instructions
Identify each statement as true or false. If false, indicate how to correct the statement.
Journalize issuance of ordinary shares.
E11-3 During its first year of operations, Punjab Limited had the following transactions pertaining to its ordinary shares.
Jan. | 10 | Issued 70,000 shares for cash at Rs5 per share. |
July | 1 | Issued 30,000 shares for cash at Rs7 per share. |
Instructions
Journalize the transactions, assuming that the ordinary shares have a par value of Rs5 per share.
Journalize the transactions, assuming that the ordinary shares are no-par with a stated value of Rs1 per share.
Journalize issuance of ordinary shares.
E11-4 Luis SLU issued 1,000 ordinary shares.
Instructions
Prepare the entry for the issuance under the following assumptions.
The shares had a par value of €5 per share and were issued for a total of €48,000.
The shares had a stated value of €5 per share and were issued for a total of €48,000.
The shares had no par or stated value and were issued for a total of €48,000.
The shares had a par value of €5 per share and were issued to attorneys for services during incorporation valued at €48,000.
The shares had a par value of €5 per share and were issued for land worth €48,000.
Journalize treasury share transactions.
E11-5 Nanjing Ltd. purchased from its shareholders 5,000 shares of its own previously issued shares for ¥250,000. It later resold 1,300 shares for ¥54 per share, then 2,000 more shares for ¥49 per share, and finally 1,700 shares for ¥40 per share.
Instructions
Prepare journal entries for the purchase of the treasury shares and the three sales of treasury shares.
Differentiate between preference and ordinary shares.
E11-6 Robydek Limited issued 100,000 £20 par value, cumulative, 9% preference shares on January 1, 2015, for £2,080,000. In December 2017, Robydek declared its first dividend of £550,000.
Instructions
Prepare Robydek’s journal entry to record the issuance of the preference shares.
If the preference shares are not cumulative, how much of the £550,000 would be paid to ordinary shareholders?
If the preference shares are cumulative, how much of the £550,000 would be paid to ordinary shareholders?
Journalize issuance of ordinary and preference shares and purchase of treasury shares.
E11-7 Sorocaba Co. had the following transactions during the current period.
Mar. | 2 | Issued 5,000 R$1 par value ordinary shares to attorneys in payment of a bill for R$44,000 for services performed in helping the company to incorporate. |
June | 12 | Issued 60,000 R$1 par value ordinary shares for cash of R$468,000. |
July | 11 | Issued 1,000 R$100 par value preference shares for cash at R$110 per share. |
Nov. | 28 | Purchased 2,000 treasury shares for R$18,000. |
Instructions
Journalize the transactions.
Journalize non-cash ordinary share transactions.
E11-8 As an auditor for the firm of Gratis and Goode, you encounter the following situations in auditing different clients.
Instructions
Prepare the journal entries for each of the situations above.
Journalize treasury share transactions.
E11-9 On January 1, 2017, the equity section of Bergin ASA shows share capital—ordinary (£5 par value) £1,500,000; share premium—ordinary £1,000,000; and retained earnings £1,200,000. During the year, the following treasury share transactions occurred.
Mar. | 1 | Purchased 50,000 shares for cash at £12 per share. |
July | 1 | Sold 10,000 treasury shares for cash at £14 per share. |
Sept. | 1 | Sold 8,000 treasury shares for cash at £10 per share. |
Instructions
Journalize the treasury share transactions.
Restate the entry for September 1, assuming the treasury shares were sold at £9 per share.
Journalize preference share transactions and indicate statement presentation.
E11-10 Suliman SJSC is authorized to issue both preference and ordinary shares. The par value of the preference shares is €50. During the first year of operations, the company had the following events and transactions pertaining to its preference shares.
Feb. | 1 | Issued 12,000 shares for cash at €53 per share. |
July | 1 | Issued 23,000 shares for cash at €57 per share. |
Instructions
Journalize the transactions.
Post to the equity accounts.
Indicate the financial statement presentation of the related accounts.
Answer questions about equity section.
E11-11 The equity section of Ahab SA at December 31 is as follows.
AHAB SA |
||
Equity | ||
Share capital—preference, cumulative, 10,000 shares authorized, 5,000 shares issued and outstanding | € 300,000 | |
Share capital—ordinary, no par, 750,000 shares authorized, 600,000 shares issued | 1,200,000 | |
Retained earnings | 1,858,000 | |
Less: Treasury shares—ordinary (75,000 shares) | 75,000 | |
Total equity | €3,283,000 |
Instructions
From a review of the equity section, as chief accountant, write a memo to the president of the company answering the following questions.
How many ordinary shares are outstanding?
Assuming there is a stated value, what is the stated value of the ordinary shares?
What is the par value of the preference shares?
If the annual dividend on preference shares is €24,000, what is the dividend rate on preference shares?
If dividends of €48,000 were in arrears on preference shares, what would be the balance in Retained Earnings?
Prepare correct entries for share capital transactions.
E11-12 Anya OAO recently hired a new accountant with extensive experience in accounting for partnerships. Because of the pressure of the new job, the accountant was unable to review his textbooks on the topic of corporation accounting. During the first month, the accountant made the following entries for the corporation’s share capital.
May 2 | Cash | 130,000 | |
Share Capital—Ordinary | 130,000 | ||
(Issued 10,000 €10 par value ordinary shares at €13 per share) | |||
10 | Cash | 580,000 | |
Share Capital—Ordinary | 580,000 | ||
(Issued 10,000 €50 par value preference shares at €58 per share) | |||
May 15 | Share Capital—Ordinary | 18,000 | |
Cash | 18,000 | ||
(Purchased 1,200 ordinary shares for the treasury at €15 per share) | |||
31 | Cash | 8,000 | |
Share Capital—Ordinary | 5,000 | ||
Gain on Sale of Shares | 3,000 | ||
(Sold 500 treasury shares at €16 per share) |
Instructions
On the basis of the explanation for each entry, prepare the entry that should have been made for the share capital transactions.
Journalize cash dividends; indicate statement presentation.
E11-13 On January 1, Chevon Enterprises SA had 98,000 no-par ordinary shares issued and outstanding. The shares have a stated value of €4 per share. During the year, the following occurred.
Apr. | 1 | Issued 18,000 additional ordinary shares for €17 per share. |
June | 15 | Declared a cash dividend of €1 per share to shareholders of record on June 30. |
July | 10 | Paid the €1 cash dividend. |
Dec. | 1 | Issued 2,000 additional ordinary shares for €19 per share. |
15 | Declared a cash dividend on outstanding shares of €1.20 per share to shareholders of record on December 31. |
Instructions
Prepare the entries, if any, on each of the three dividend dates.
How are dividends and dividends payable reported in the financial statements prepared at December 31?
Journalize share dividends.
E11-14 On January 1, 2017, Lanie Limited had £1,000,000 of ordinary shares outstanding that were issued at par. It also had retained earnings of £750,000. The company issued 40,000 ordinary shares at par on July 1 and earned net income of £400,000 for the year.
Instructions
Journalize the declaration of a 15% share dividend on December 10, 2017, for the following independent assumptions.
Par value is £8, and market price is £18.
Par value is £5, and market price is £20.
Compare effects of a share dividend and a share split.
E11-15 On October 31, the equity section of Lucerne Company AG consists of share capital—ordinary CHF300,000 and retained earnings CHF860,000. Lucerne is considering the following two courses of action: (1) declaring a 7% share dividend on the 50,000, CHF6 par value shares outstanding, or (2) effecting a 2-for-1 share split that will reduce par value to CHF3 per share. The current market price is CHF13 per share.
Instructions
Prepare a tabular summary of the effects of the alternative actions on the components of equity, outstanding shares, and par value per share. Use the following column headings: Before Action, After Share Dividend, and After Share Split.
Prepare correcting entries for dividends and a share split.
E11-16 Before preparing financial statements for the current year, the chief accountant for Paul Company discovered the following errors in the accounts.
Instructions
Prepare the correcting entries at December 31.
Prepare a retained earnings statement.
E11-17 On January 1, 2017, Richard Industries Ltd. had retained earnings of £550,000. During the year, Richard had the following selected transactions.
Instructions
Prepare a retained earnings statement for the year.
Prepare a retained earnings statement.
E11-18 Bindra Company A.. reported retained earnings at December 31, 2016, of 340,000. Bindra had 200,000 ordinary shares outstanding at January 1, 2017.
The following transactions occurred during 2017.
Instructions
Prepare a retained earnings statement for 2017.
Classify equity accounts.
E11-19 The ledger of Summit SA contains the following accounts: Share Capital—Ordinary, Share Capital—Preference, Treasury Shares, Share Premium—Preference, Share Premium—Ordinary, Share Premium—Treasury, and Retained Earnings.
Instructions
Classify each account using the following table headings.
Account | Share Capital | Share Premium | Retained Earnings | Other |
Prepare an equity section.
E11-20 The following accounts appear in the ledger of Tiger Ltd. after the books are closed at December 31.
Share Capital—Ordinary, no par, ¥1 stated value, 400,000 shares authorized; 300,000 shares issued | ¥ 300,000 |
Ordinary Share Dividends Distributable | 30,000 |
Share Premium—Ordinary | 1,200,000 |
Share Capital—Preference, ¥5 par value, 8%, 40,000 shares authorized; 30,000 shares issued | 150,000 |
Retained Earnings | 800,000 |
Treasury Shares—Ordinary (10,000 shares) | 65,000 |
Share Premium—Preference | 50,000 |
Instructions
Prepare the equity section at December 31, assuming retained earnings is restricted for plant expansion in the amount of ¥150,000.
Prepare an equity section.
E11-21 Perrin SA reported the following balances at December 31, 2016: share capital—ordinary €400,000; share premium—ordinary €220,000; and retained earnings €250,000. During 2017, the following transactions affected equity.
Instructions
Prepare the equity section of Perrin SA’s December 31, 2017, statement of financial position.
Prepare an income statement and compute return on ordinary shareholders’ equity.
E11-22 In 2017, Orasco Company SA had net sales of R$600,000 and cost of goods sold of R$360,000. Operating expenses were R$153,000, and interest expense was R$7,500. The corporation’s tax rate is 25%. The corporation declared preference dividends of R$12,000 in 2017, and its average ordinary shareholders’ equity during the year was R$180,000.
Instructions
Prepare an income statement for Orasco Company SA.
Compute Orasco’s return on ordinary shareholders’ equity for 2017.
Prepare an equity section.
*E11-23 The equity section of Atrio Ltd. showed the following: share premium €6,101, share capital—ordinary €925, share capital—preference €58, retained earnings €7,420, and treasury shares €2,828. (All amounts are in millions.)
The preference shares have 577,740 shares authorized, with a par value of €100 and an annual €3.50 per share cumulative dividend preference. At December 31, 577,649 preference shares are issued and 546,024 shares are outstanding. There are 1.8 billion shares of €1 par value ordinary shares authorized, of which 924.6 million are issued and 844.8 million are outstanding at December 31.
Instructions
Prepare the equity section, including disclosure of all relevant data.
Compute the book value per share of ordinary shares, assuming there are no preference dividends in arrears. (Round to two decimals.)
Compute book value per share with preference shares.
*E11-24 At December 31, Gorden Limited has total equity of £3,200,000. Included in this total are share capital—preference £500,000 and share premium—preference £50,000. There are 10,000 shares of £50 par value, 8% cumulative preference shares outstanding. At year-end, 200,000 ordinary shares are outstanding.
Instructions
Compute the book value per share of ordinary shares, under each of the following assumptions.
There are no preference dividends in arrears, and the preference shares do not have a call price.
Preference dividends are one year in arrears, and the preference shares have a call price of £60 per share.
Compute book value per share; indicate account balances after a share dividend.
*E11-25 On October 1, Venden Limited’s equity is as follows.
Share capital—ordinary, £5 par value | £400,000 |
Share premium—ordinary | 25,000 |
Retained earnings | 225,000 |
Total equity | £650,000 |
On October 1, Venden declares and distributes a 12% share dividend when the market price of the shares is £14 per share.
Instructions
Compute the book value per share (1) before the share dividend and (2) after the share dividend. (Round to two decimals.)
Indicate the balances in the three equity accounts after the dividend shares have been distributed.
Journalize share transactions, post, and prepare share capital section.
P11-1A Gão Limited was organized on January 1, 2017. It is authorized to issue 10,000 8%, HK$1,000 par value preference shares, and 500,000 no-par ordinary shares with a stated value of HK$20 per share. The following share transactions were completed during the first year.
Jan. | 10 | Issued 100,000 ordinary shares for cash at HK$48 per share. |
Mar. | 1 | Issued 5,000 preference shares for cash at HK$1,050 per share. |
Apr. | 1 | Issued 18,000 ordinary shares for land. The asking price of the land was HK$980,000. The fair value of the land was HK$920,000. |
May | 1 | Issued 80,000 ordinary shares for cash at HK$45 per share. |
Aug. | 1 | Issued 10,000 ordinary shares to attorneys in payment of their bill of HK$320,000 for services provided in helping the company organize. |
Sept. | 1 | Issued 10,000 ordinary shares for cash at HK$50 per share. |
Nov. | 1 | Issued 1,000 preference shares for cash at HK$1,060 per share. |
Instructions
Journalize the transactions.
Post to the equity accounts. (Use J5 as the posting reference.)
Prepare the share capital section of the statement of financial position at December 31, 2017.
Journalize and post treasury share transactions, and prepare equity section.
P11-2A Elston Limited had the following equity accounts on January 1, 2017: Share Capital—Ordinary (£5 par) £400,000, Share Premium—Ordinary £200,000, and Retained Earnings £100,000. In 2017, the company had the following treasury share transactions.
Mar. | 1 | Purchased 5,000 shares at £9 per share. |
June | 1 | Sold 500 shares at £12 per share. |
Sept. | 1 | Sold 2,500 shares at £10 per share. |
Dec. | 1 | Sold 1,000 shares at £6 per share. |
Elston uses the cost method of accounting for treasury shares. In 2017, the company reported net income of £34,000.
Instructions
Journalize the treasury share transactions, and prepare the closing entry at December 31, 2017, for net income.
Open accounts for (1) Share Premium—Treasury, (2) Treasury Shares, and (3) Retained Earnings. Post to these accounts using J10 as the posting reference.
Prepare the equity section for Elston Limited at December 31, 2017.
Journalize and post transactions, prepare equity section.
P11-3A The equity accounts of Terrell SE on January 1, 2017, were as follows.
Share Capital—Preference (9%, €50 par, cumulative, 10,000 shares authorized) | € 400,000 |
Share Capital—Ordinary (€1 stated value, 2,000,000 shares authorized) | 1,000,000 |
Share Premium—Preference | 100,000 |
Share Premium—Ordinary | 1,450,000 |
Retained Earnings | 1,816,000 |
Treasury Shares—Ordinary (20,000 shares) | 50,000 |
During 2017, the corporation had the following transactions and events pertaining to its equity.
Feb. | 1 | Issued 30,000 ordinary shares for €120,000. |
Apr. | 14 | Sold 9,000 treasury shares—ordinary for €42,000. |
Sept. | 3 | Issued 7,000 ordinary shares for a patent valued at €32,000. |
Nov. | 10 | Purchased 1,000 ordinary shares for the treasury at a cost of €6,000. |
Dec. | 31 | Determined that net income for the year was €452,000. |
No dividends were declared during the year.
Instructions
Journalize the transactions and the closing entry for net income.
Enter the beginning balances in the accounts, and post the journal entries to the equity accounts. (Use J5 for the posting reference.)
Prepare an equity section at December 31, 2017, including the disclosure of the preference dividends in arrears.
Prepare dividend entries and equity section.
P11-4A On January 1, 2017, Prasad SpA had the following equity accounts.
Share Capital—Ordinary (€25 par value, 48,000 shares issued and outstanding) | €1,200,000 |
Share Premium—Ordinary | 200,000 |
Retained Earnings | 600,000 |
During the year, the following transactions occurred.
Feb. | 1 | Declared a €1 cash dividend per share to shareholders of record on February 15, payable March 1. |
Mar. | 1 | Paid the dividend declared in February. |
Apr. | 1 | Announced a 5-for-1 share split. Prior to the split, the market price per share was €36. |
July | 1 | Declared a 10% share dividend to shareholders of record on July 15, distributable July 31. On July 1, the market price was €7 per share. |
July | 31 | Issued the shares for the share dividend. |
Dec. | 1 | Declared a €0.40 per share dividend to shareholders of record on December 15, payable January 5, 2018. |
31 | Determined that net income for the year was €350,000. |
Instructions
Journalize the transactions and the closing entries for net income and dividends.
Enter the beginning balances, and post the entries to the equity accounts. (Note: Open additional equity accounts as needed.)
Prepare an equity section at December 31.
Prepare retained earnings statement and equity section, and allocation of dividends.
P11-5A The post-closing trial balance of Russo Company SpA at December 31, 2017, contains the following equity accounts.
Share Capital—Preference (12,000 shares issued) | € 600,000 |
Share Capital—Ordinary (250,000 shares issued) | 2,500,000 |
Share Premium—Preference | 250,000 |
Share Premium—Ordinary | 425,000 |
Ordinary Share Dividends Distributable | 250,000 |
Retained Earnings | 1,078,000 |
A review of the accounting records reveals the following.
Instructions
Reproduce the Retained Earnings account for 2017.
Prepare a retained earnings statement for 2017.
Prepare an equity section at December 31, 2017.
Compute the allocation of the cash dividend to preference and ordinary shares.
Prepare entries for share transactions and prepare equity section.
P11-6A Jude Limited has been authorized to issue 20,000 £100 par value, 10%, non-cumulative preference shares and 1,000,000 no-par ordinary shares. The corporation assigned a £2.50 stated value to the ordinary shares. At December 31, 2017, the ledger contained the following balances pertaining to equity.
Share Capital—Preference | £ 120,000 |
Share Premium—Preference | 12,000 |
Share Capital—Ordinary | 1,000,000 |
Share Premium—Ordinary | 1,600,000 |
Treasury Shares—Ordinary (1,000 shares) | 9,000 |
Share Premium—Treasury | 1,000 |
Retained Earnings | 82,000 |
The preference shares were issued for land having a fair value of £132,000. All ordinary shares issued were for cash. In November, 1,500 ordinary shares were purchased for the treasury at a per share cost of £9. In December, 500 treasury shares were sold for £11 per share. No dividends were declared in 2017.
Instructions
Prepare the equity section at December 31, 2017.
Prepare dividend entries and equity section.
P11-7A On January 1, 2017, Primo plc had the following equity accounts.
Share Capital—Ordinary (£10 par value, 75,000 shares issued and outstanding) | £750,000 |
Share Premium—Ordinary | 200,000 |
Retained Earnings | 540,000 |
During the year, the following transactions occurred.
Jan. | 15 | Declared a £2 cash dividend per share to shareholders of record on January 31, payable February 15. |
Feb. | 15 | Paid the dividend declared in January. |
Apr. | 15 | Declared a 10% share dividend to shareholders of record on April 30, distributable May 15. On April 15, the market price of the shares was £15 per share. |
May | 15 | Issued the shares for the share dividend. |
July | 1 | Announced a 2-for-1 share split. The market price per share prior to the announcement was £15. (The new par value is £5.) |
Dec. | 1 | Declared a £0.60 per share cash dividend to shareholders of record on December 15, payable January 10, 2018. |
31 | Determined that net income for the year was £260,000. |
Instructions
Journalize the transactions and the closing entries for net income and dividends.
Enter the beginning balances, and post the entries to the equity accounts. (Note: Open additional equity accounts as needed.)
Prepare equity section; compute book value per share.
P11-8A* The following equity accounts are in the ledger of Westin SE at December 31, 2017.
Share Capital—Ordinary (€10 stated value) | €1,500,000 |
Share Premium—Treasury | 6,000 |
Share Premium—Ordinary | 690,000 |
Share Premium—Preference | 42,400 |
Share Capital—Preference (8%, €100 par, non-cumulative) | 360,000 |
Retained Earnings | 776,000 |
Treasury Shares—Ordinary (7,000 shares) | 92,000 |
Instructions
Compute the book value per share of the ordinary shares, assuming the preference shares have a call price of €110 per share.
Prepare statement of changes in equity.
P11-9A* On January 1, 2017, Chamblin AG had the following equity balances.
Share Capital—Ordinary (400,000 shares issued) | CHF800,000 |
Share Premium—Ordinary | 500,000 |
Ordinary Share Dividends Distributable | 120,000 |
Retained Earnings | 600,000 |
During 2017, the following transactions and events occurred.
Instructions
Prepare a statement of changes in equity for the year.
Journalize share transactions, post, and prepare share capital section.
P11-1B Welles plc was organized on January 1, 2017. It is authorized to issue 20,000 6%, £40 par value preference shares, and 500,000 no-par ordinary shares with a stated value of £1 per share. The following share transactions were completed during the first year.
Jan. | 10 | Issued 74,000 ordinary shares for cash at £3 per share. |
Mar. | 1 | Issued 10,000 preference shares for cash at £43 per share. |
Apr. | 1 | Issued 25,000 ordinary shares for land. The asking price of the land was £90,000. The company’s estimate of fair value of the land was £75,000. |
May | 1 | Issued 75,000 ordinary shares for cash at £4 per share. |
Aug. | 1 | Issued 10,000 ordinary shares to attorneys in payment of their bill for £44,000 for services performed in helping the company organize. |
Sept. | 1 | Issued 5,000 ordinary shares for cash at £6 per share. |
Nov. | 1 | Issued 2,000 preference shares for cash at £45 per share. |
Instructions
Journalize the transactions.
Post to the equity accounts. (Use J1 as the posting reference.)
Prepare the share capital section of the statement of financial position at December 31, 2017.
Journalize and post treasury share transactions, and prepare equity section.
Plover Limited had the following equity accounts on January 1, 2017: Share Capital—Ordinary (£1 par) £400,000, Share Premium—Ordinary £500,000, and Retained Earnings £100,000. In 2017, the company had the following treasury share transactions.
Mar. | 1 | Purchased 5,000 shares at £7 per share. |
June | 1 | Sold 800 shares at £10 per share. |
Sept. | 1 | Sold 1,700 shares at £9 per share. |
Dec. | 1 | Sold 1,000 shares at £5 per share. |
Plover uses the cost method of accounting for treasury shares. In 2017, the company reported net income of £80,000.
Instructions
Journalize the treasury share transactions, and prepare the closing entry at December 31, 2017, for net income.
Open accounts for (1) Share Premium—Treasury, (2) Treasury Shares, and (3) Retained Earnings. Post to these accounts using J12 as the posting reference.
Prepare the equity section for Plover Limited at December 31, 2017.
Journalize and post transactions, prepare equity section.
P11-3B The equity accounts of Marya SA on January 1, 2017, were as follows.
Share Capital—Preference (9%, €100 par, cumulative, 5,000 shares authorized) | €300,000 |
Share Capital—Ordinary (€3 stated value, 300,000 shares authorized) | 660,000 |
Share Premium—Preference | 20,000 |
Share Premium—Ordinary | 396,000 |
Retained Earnings | 488,000 |
Treasury Shares—Ordinary (5,000 shares) | 30,000 |
During 2017, the corporation had the following transactions and events pertaining to its equity.
Feb. | 1 | Issued 2,800 ordinary shares for €18,200. |
Mar. | 20 | Purchased 1,200 additional treasury shares (ordinary) at €6 per share. |
June | 14 | Sold 4,000 treasury shares (ordinary) for €26,000. |
Sept. | 3 | Issued 2,000 ordinary shares for a patent valued at €14,000. |
Dec. | 31 | Determined that net income for the year was €365,000. |
No dividends were declared during the year.
Instructions
Journalize the transactions and the closing entry for net income.
Enter the beginning balances in the accounts and post the journal entries to the equity accounts. (Use J1 as the posting reference.)
Prepare an equity section at December 31, 2017, including the disclosure of the preference dividends in arrears.
Prepare dividend entries and equity section.
P11-4B On January 1, 2017, Belgium Industries SA had the following equity accounts.
Share Capital—Ordinary (€4 par value, 250,000 shares issued and outstanding) | €1,000,000 |
Share Premium—Ordinary | 200,000 |
Retained Earnings | 840,000 |
During the year, the following transactions occurred.
Jan. | 15 | Declared a €1 cash dividend per share to shareholders of record on January 31, payable February 15. |
Feb. | 15 | Paid the dividend declared in January. |
Apr. | 15 | Declared a 10% share dividend to shareholders of record on April 30, distributable May 15. On April 15, the market price was €11 per share. |
May | 15 | Issued the shares for the share dividend. |
July | 1 | Announced a 2-for-1 share split. The market price per share prior to the announcement was €12. (The new par value is €2.) |
Dec. | 1 | Declared a €0.50 per share cash dividend to shareholders of record on December 15, payable January 10, 2018. |
31 | Determined that net income for the year was €264,000. |
Instructions
Journalize the transactions and the closing entries for net income and dividends.
Enter the beginning balances, and post the entries to the equity accounts. (Note: Open additional equity accounts as needed.)
Prepare an equity section at December 31.
Prepare retained earnings statement and equity section.
P11-5B On December 31, 2016, Andes Company SA had 1,500,000 €10 par ordinary shares issued and outstanding. The equity accounts at December 31, 2016, had the following balances.
Share Capital—Ordinary | €15,000,000 |
Share Premium—Ordinary | 1,500,000 |
Retained Earnings | 900,000 |
Transactions during 2017 and other information related to equity accounts were as follows.
Instructions
Prepare a retained earnings statement for the year ended December 31, 2017.
Prepare the equity section of Andes’s statement of financial position at December 31, 2017.
Prepare retained earnings statement and equity section, and allocation of dividends.
P11-6B The ledger of Fortaleza SA at December 31, 2017, after the books have been closed, contains the following equity accounts.
Share Capital—Preference (8,000 shares issued) | R$ 800,000 |
Share Capital—Ordinary (400,000 shares issued) | 2,000,000 |
Share Premium—Preference | 100,000 |
Share Premium—Ordinary | 1,220,000 |
Ordinary Share Dividends Distributable | 200,000 |
Retained Earnings | 2,520,000 |
A review of the accounting records reveals the following.
Instructions
Reproduce the Retained Earnings account (T-account) for 2017.
Prepare a retained earnings statement for 2017.
Prepare an equity section at December 31, 2017.
Compute the allocation of the cash dividend to preference and ordinary shares.
Prepare equity section; compute book value per share.
*P11-7B The following equity accounts are in the ledger of Crivello SpA at December 31, 2017.
Share Capital—Ordinary (€3 stated value) | €2,250,000 |
Share Premium—Treasury | 10,000 |
Share Premium—Ordinary | 1,500,000 |
Share Premium—Preference | 220,000 |
Share Capital—Preference (8%, €50 par, non-cumulative) | 800,000 |
Retained Earnings | 1,448,000 |
Treasury Shares—Ordinary (10,000 shares) | 68,000 |
Instructions
Prepare an equity section at December 31, 2017.
Compute the book value per share of the ordinary shares, assuming the preference shares have a call price of €60 per share.
CP11-1 Voltaire Enterprises SA’s statement of financial position at December 31, 2016, is presented below.
VOLTAIRE ENTERPRISES SA Statement of Financial Position December 31, 2016 |
|||
Land | € 40,000 | Share capital—ordinary | |
Buildings | 130,000 | (€1 par) | € 50,000 |
Accumulated depreciation—buildings | (20,000) | Retained earnings | 147,400 |
Supplies | 4,400 | Accounts payable | 25,600 |
Accounts receivable | 45,500 | €223,000 | |
Allowance for doubtful accounts | (1,500) | ||
Cash | 24,600 | ||
€223,000 |
During 2017, the following transactions occurred.
Adjustment data:
Instructions
(You may want to set up T-accounts to determine ending balances.)
Prepare journal entries for the transactions listed above and adjusting entries.
Prepare an adjusted trial balance at December 31, 2017.
Prepare an income statement and a retained earnings statement for the year ending December 31, 2017, and a classified statement of financial position as of December 31, 2017.
(Note: This is a continuation of the Matcha Creations problem from Chapters 1–10.)
MC11 Mei-ling and her friend Curtis Lesperance decide that they can benefit from joining Matcha Creations and Curtis’s coffee shop. In the first part of this problem, they come to you with questions about setting up a corporation for their new business. In the second part of the problem, they want your help in preparing financial information following the first year of operations of their new business, Matcha & Coffee Creations.
Go to the book’s companion website, www.wiley.com/college/weygandt, to see the completion of this problem.
BYP11-1 The equity section for TSMC is shown in Appendix A. The complete annual report, including the notes to the financial statements (use Note 24), is available in the Investors section of the company’s website at www.tsmc.com.
Instructions
What is the par or stated value per share of TSMC’s ordinary shares?
What percentage of TSMC’s authorized ordinary shares was issued at December 31, 2013?
How many ordinary shares were outstanding at December 31, 2013, and at December 31, 2012?
BYP11-2 Nestlé’s financial statements are presented in Appendix B, and its complete annual report is available at www.nestle.com. Petra Foods’ financial statements are presented in Appendix C, and its complete annual report is available at www.petrafoods.com.
Instructions
Use the financial statements provided in this textbook, as well as the notes to the financial statements provided at each company’s website, to answer the following questions.
What was the amount of basic earnings per share reported by each company for the most recent fiscal year shown? (For Petra Foods, use earnings related to continuing operations.)
Compute the return on ordinary shareholders’ equity for both companies for the most recent fiscal year shown. (For Petra Foods, use earnings related to continuing operations.) Discuss the relative profitability of the two companies.
What was the total amount of dividends paid by each company for the most recent fiscal year shown?
BYP11-3 Use the equity section of an annual report and identify the major components.
Address: www.annualreports.com, or go to www.wiley.com/college/weygandt
Steps
Instructions
Answer the following questions.
What is the company’s name?
What classes of share capital has the company issued?
For each class:
What are the company’s retained earnings?
Has the company acquired treasury shares? How many?
BYP11-4 The shareholders’ meeting for Kissinger Company SE has been in progress for some time. The chief financial officer for Kissinger is presently reviewing the company’s financial statements and is explaining the items that comprise the equity section of the statement of financial position for the current year. The equity section of Kissinger at December 31, 2017, is as follows.
KISSINGER COMPANY SE Statement of Financial Position (partial) December 31, 2017 |
|||
Share capital—preference, authorized 1,000,000 shares cumulative, €100 par value, €8 per share, 6,000 shares issued and outstanding | € 600,000 | ||
Share capital—ordinary, authorized 5,000,000 shares, €1 par value, 3,000,000 shares issued, and 2,700,000 outstanding | 3,000,000 | ||
Share premium—preference | 50,000 | ||
Share premium—ordinary | 25,000,000 | ||
Retained earnings | 900,000 | ||
Less: Treasury shares (300,000 shares) | 9,300,000 | ||
Total equity | €20,250,000 |
At the meeting, shareholders have raised a number of questions regarding the equity section.
Instructions
With the class divided into groups, answer the following questions as if you were the chief financial officer for Kissinger Company SE.
“What does the cumulative provision related to the preference shares mean?”
“I thought the ordinary shares were presently selling at €29.75, but the company has the shares stated at €1 per share. How can that be?”
“Why is the company buying back its ordinary shares? Furthermore, the treasury shares have a debit balance because they are subtracted from equity. Why are treasury shares not reported as an asset if they have a debit balance?”
BYP11-5 Jerrod Platt, your uncle, is an inventor who has decided to incorporate. Uncle Jerrod knows that you are an accounting major at U.N.O. In a recent letter to you, he ends with the question, “I’m filling out an incorporation application. Can you tell me the difference in the following terms: (1) authorized shares, (2) issued shares, (3) outstanding shares, and (4) preference shares?”
Instructions
In a brief note, differentiate for Uncle Jerrod among the four different share terms. Write the letter to be friendly, yet professional.
BYP11-6 The R&D division of Hancock Chemical Ltd. has just developed a chemical for sterilizing the vicious Brazilian “killer bees” which are invading Mexico and the southern states of the United States. The president of Hancock is anxious to get the chemical on the market to boost the company’s profits. He believes his job is in jeopardy because of decreasing sales and profits. Hancock has an opportunity to sell this chemical in Central American countries, where the laws are much more relaxed than in the United States.
The director of Hancock’s R&D division strongly recommends further testing in the laboratory for side-effects of this chemical on other insects, birds, animals, plants, and even humans. He cautions the president, “We could be sued from all sides if the chemical has tragic side-effects that we didn’t even test for in the labs.” The president answers, “We can’t wait an additional year for your lab tests. We can avoid losses from such lawsuits by establishing a separate wholly owned corporation to shield Hancock Ltd. from such lawsuits. We can’t lose any more than our investment in the new corporation, and we’ll invest in just the patent covering this chemical. We’ll reap the benefits if the chemical works and is safe, and avoid the losses from lawsuits if it’s a disaster.” The following week, Hancock creates a new wholly owned corporation called Badell Ltd., sells the chemical patent to it for $10, and watches the spraying begin.
Instructions
Who are the stakeholders in this situation?
Are the president’s motives and actions ethical?
Can Hancock shield itself against losses of Badell Ltd.?
p. 544 How to Read Share Quotes Q: For shares traded on organized securities exchanges, how are the prices per share established? What factors might influence the price of shares in the marketplace? A: The prices per share are established by the interaction between buyers and sellers of the shares. The price of shares is influenced by a company’s earnings and dividends as well as by factors beyond a company’s control, such as changes in interest rates, labor strikes, scarcity of supplies or resources, and politics. The number of willing buyers and sellers (demand and supply) also plays a part in the price of shares.
p. 546 The Impact of Corporate Social Responsibility Q: Why are CSR-related shareholder proposals increasing? A: The increase in shareholder proposals reflects a growing belief that a company’s social and environmental policies correlate strongly with its risk-management strategy and ultimately its financial performance.
p. 551 Why Would a Company Buy Its Own Shares? Q: What signal might a large share repurchase send to investors regarding management’s belief about the company’s growth opportunities? A: When a company has many growth opportunities, it will normally conserve its cash in order to be better able to fund expansion. A large use of cash to buy back shares (and essentially shrink the company) would suggest that management was not optimistic about its growth opportunities.
p. 561 A No-Split Philosophy Q: Why does Warren Buffett usually oppose share splits? A: Mr. Buffett prefers to attract shareholders who will make a long-term commitment to his company, as opposed to traders who will only hold their investment for a short period of time. He believes that a high share price discourages short-term investment.
Compare the accounting for equity under IFRS and U.S. GAAP.
The accounting for transactions related to equity, such as issuance of shares and purchase of treasury shares, are similar under IFRS and GAAP. Major differences relate to terminology used, introduction of items such as revaluation surplus, and presentation of equity information. The basic accounting for cash and share dividends is essentially the same under both GAAP and IFRS although IFRS terminology may differ.
There are often terminology differences for equity accounts. The following summarizes some of the common differences in terminology.
GAAP | IFRS |
Common stock | Share capital—ordinary |
Stockholders | Shareholders |
Authorized stock | Authorized share capital |
Preferred stock | Share capital—preference |
Paid-in capital | Issued/allocated share capital |
Paid-in capital in excess of par—common stock | Share premium—ordinary |
Paid-in capital in excess of par—preferred stock | Share premium—preference |
Retained earnings | Retained earnings or Retained profits |
Retained earnings deficit | Accumulated losses |
Accumulated other comprehensive income | General reserve and other reserve accounts |
As an example of how similar transactions use different terminology under GAAP, consider the accounting for the issuance of 1,000 shares of $1 par value ordinary shares for $5 per share. Under GAAP, the entry is as follows.
Cash | 5,000 | |
Common Stock | 1,000 | |
Paid-in Capital in Excess of Par—Common Stock | 4,000 |
The IASB and the FASB are currently working on a project related to financial statement presentation. An important part of this study is to determine whether certain line items, subtotals, and totals should be clearly defined and required to be displayed in the financial statements. For example, it is likely that the statement of changes in equity and its presentation will be examined closely.
Both the IASB and FASB are working toward convergence of any remaining differences related to earnings per share computations. This convergence will deal with highly technical changes beyond the scope of this textbook.
Under GAAP, a purchase by a company of its own shares is recorded by:
an increase in Treasury Stock.
a decrease in accumulated comprehensive income.
a decrease in retained earnings.
All of these are acceptable treatments.
Which of the following is true?
In the United States, the primary corporate shareholders are financial institutions.
Share capital means total assets under IFRS.
The IASB and FASB are presently studying how financial statement information should be presented.
The accounting for treasury shares differs extensively between GAAP and IFRS.
Under GAAP, the amount of capital received in excess of par value would be credited to:
Retained Earnings.
Paid-in Capital in Excess of Par—
Share Premium.
Par value is not used under GAAP. Common Stock.
Which of the following is false?
Under GAAP, companies cannot record gains on transactions involving their own shares.
Under IFRS, companies cannot record gains on transactions involving their own shares.
Under GAAP, the income statement is presented in a one- or two-statement format.
Under IFRS, a company records a revaluation surplus when it experiences an increase in the price of its ordinary shares.
Which of the following does not represent a pair of GAAP/IFRS-comparable terms?
Additional paid-in capital/Share premium.
Treasury stock/Repurchase reserve.
Common stock/Share capital.
Preferred stock/Preference shares.
The basic accounting for cash dividends and share dividends:
is different under IFRS versus GAAP.
is the same under IFRS and GAAP.
differs only for the accounting for cash dividends between GAAP and IFRS.
differs only for the accounting for share dividends between GAAP and IFRS.
Which item in not considered part of reserves?
Accumulated other comprehensive income.
Revaluation surplus.
Retained earnings.
Issued shares.
Under GAAP, a statement of comprehensive income must include:
accounts payable.
retained earnings.
income tax expense.
preferred stock.
Which term is used to describe total equity under GAAP?
Other comprehensive income.
Capital and reserves.
Stockholders’ equity.
All of the above.
Earnings per share computations related to IFRS and GAAP:
are essentially similar.
result in an amount referred to as earnings per share.
must deduct preferred (preference) dividends when computing earnings per share.
All of the above.
GAAP11-1 On May 10, Romano Corporation issues 1,000 shares of $10 par value ordinary shares for cash at $18 per share. Journalize the issuance of the shares using GAAP.
GAAP11-1 Ingram Corporation has the following accounts at December 31: Common Stock, $10 par, 5,000 shares issued, $50,000; Paid-in Capital in Excess of Par—Common Stock, $10,000; Retained Earnings, $45,000; and Treasury Stock, 500 shares, $11,000. Prepare the stockholders’ equity section of the balance sheet (statement of financial position) using GAAP.
GAAP11-3 Sorocaba Co. had the following transactions during the current period.
Mar. | 2 | Issued 5,000 shares of $1 par value ordinary shares to attorneys in payment of a bill for $30,000 for services performed in helping the company to incorporate. |
June | 12 | Issued 60,000 shares of $1 par value ordinary shares for cash of $375,000. |
July | 11 | Issued 1,000 shares of $100 par value preference shares for cash at $110 per share. |
Nov. | 28 | Purchased 2,000 treasury shares for $80,000. |
Instructions
Journalize the above transactions using GAAP.
GAAP11-4 The financial statements of Apple are presented in Appendix D. The company’s complete annual report, including the notes to its financial statements, is available at http://investor.apple.com.
Instructions
Use the company’s financial statements and notes to the financial statements to answer the following questions.
What is the par or stated value per share of Apple’s common stock?
What percentage of Apple’s authorized common stock was issued at September 28, 2013? (Round to the nearest full percent.)
How many shares of common stock were outstanding at September 29, 2012, and at September 28, 2013?
Calculate the earnings per share and return on common stockholders’ equity for 2013.