Chapter 10

Shareholders’ Equity
Learning Objective 1
Explain the features of a corporation/
Limited Liability Companies

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Corporate Characteristics
ADVANTAGES DISADVANTAGES
• Can raise more capital • Separation of ownership
• Continuous life and management/control
• Ease of transferring • Corporate taxation
ownership ▫ Potential Double
• Limited liability of Taxation
shareholders • Government regulation
(Companies Act)

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Organizing a Corporation
• Corporate organizers (incorporators) obtain a
charter from the government
▫ (Articles of Incorporation/Association) Charter
includes authorization to issue shares
• Incorporators:
▫ Pay fees
▫ Sign the charter
▫ File documents with the state
▫ Agree to set of bylaws
• In Hong Kong, Companies Registry
▫ see www.cr.gov.hk 5

▫ Inland Revenue Department (IRD)

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 Shareholders (Owners)

Board of Directors (elected by SH)

Chief Executive Officer (CEO)

Chief Operating Officer (COO)

Director, Director, Chief Director, Company

Sales Manufacturing Financial Personnel Secretary
Officer
Separation of Duties
Controller (Accounting) Treasurer (Finance)
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Shareholder Rights

Vote Dividends

Liquidation Preemption

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Shareholder Rights
• 1. Vote.
▫ The right to participate in management by voting on matters that come before
the shareholders. This is the shareholder’s sole voice in the management of the
corporation, typically during the Annual General Meeting (AGM). Including,
approving Executive Compensation, Approving Auditor, Approving Dividends
• 2. Dividends.
▫ The right to receive a proportionate part of any dividend, if declared by the
board. Each share in a particular class receives an equal dividend.
• 3. Liquidation.
▫ The right to receive a proportionate share of any assets remaining after the
corporation pays its liabilities in liquidation. Liquidation means to go out of
business, sell the assets, pay all liabilities, and distribute any remaining cash to
the owners (residual claimant).
• 4. Preemption.
▫ The right to maintain one’s proportionate ownership in the corporation.
Sometimes required by law, sometimes company grant this right.

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Shareholders’ Equity
Paid-in or Contributed Retained capital
capital
• Amount shareholders • Amount earned by
have contributed profitable operations
• Ex: Share Capital, • Ex: Retained
Common Stock = Earnings
Ordinary Shares,
Preferred Stock =
Preferred Shares

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Classes of Shares
ORDINARY/ PREFERENCE/
Common Preferred
• Basic form of share • Has advantages over
capital common
▫ Receive dividends first
• Has four basic rights (at ▫ Receive assets first in liquidation
least voting) • Shareholders earn a fixed
• Shareholders benefit dividend
most if corporation • Very few corporations (7%)
succeeds issue
▫ Take more risk • Disadvantage
▫ Sometimes does not have
voting right
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Comparison of Issuing Shares and
Debt
Ordinary Preference Long-term
share share debt
Obligation to repay No No Yes
principal

Dividends/interest Dividends are Dividends are Interest

not tax not tax expense is
deductible deductible tax
deductible
Obligation to pay Only after Only after At fixed rates
dividends/interest declaration declaration and date

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Par Value = Nominal Value
• Arbitrary amount assigned to a share: minimal
price at which the company can sell the shares
• Usually set low to avoid legal issues
• No-par shares
▫ May have a stated value

• In Hong Kong, since 3 March 2014, all shares

became no-par
▫ http://www.cr.gov.hk/en/faq/faq05_c.htm#01

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Learning Objective Two
Account for the issuance of shares

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 Ordinary Shares at Par
• Receive cash equal to the par value for the sale
• DR Cash
• CR Ordinary Shares
• Ex: Issue 6,200,000 shares of $10 par stock for
$10 each.

JOURNAL
Date Accounts and explanation Debit Credit
Cash (6,200,000 * $10) 62,000,000
Ordinary shares (Par*# of share) 62,000,000
To issue ordinary shares.

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Ordinary Shares above Par
• DR Cash (shares * sale price)
• CR Ordinary Shares (shares * par value)
• CR Additional Paid-in Capital (shares*(sale price – par))
• Ex: Issue 6,200,000 shares of $0.01 par stock for
$10 each.
JOURNAL
Date Accounts and explanation Debit Credit
Cash 62,000,000
Ordinary shares (par*# shares) 62,000
Paid-in capital in excess of par = 61,938,000
Additional Paid-in capital (APIC)
To issue ordinary shares above par
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Ordinary Shares with No-Par Values
• Dr Cash (shares * price)
• Cr Share capital (shares * price)
• Ex: Sell X shares for $2,893,154

JOURNAL
Date Accounts and explanation Debit Credit
Cash 2,893,154
Share capital 2,893,154
To record issuance of no-par shares.

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 Shares Issued for Non-Cash Assets
• Asset received is recorded at current market value (we have
to use the value which is most reasonable) EXAMPLE
1
• Ex: Exchange 15,000 shares of $1 par (with a market value of
9/sh) for equipment worth 4,000 and building worth 120,000
(assume stock price is more reasonable

JOURNAL
Date Accounts and explanation Debit Credit
Equipment (4/124)*135 4,355
Building (120/124)*135 130,645
Ordinary Shares (par*# of shares) 15,000
Paid-in capital in excess of par 120,000
To issue $1 par shares in exchange for equipment and a building

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 Shares Issued for Non-Cash Assets
• Asset received is recorded at current market value (we
have to use the value which is most reasonable)
Example 2
• Ex: Exchange 15,000 shares of $1 par (with a market
value of 9/sh) for equipment worth 4,000 and building
worth 120,000 (assume asset price is more reasonable)
JOURNAL
Date Accounts and explanation Debit Credit
Equipment 4,000
Building 120,000
Ordinary Shares (par*# of shares) 15,000
Paid-in capital in excess of par 109,000
To issue $1 par shares in exchange for equipment and a building

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 Shares Issued for Services
• Asset received is recorded at current market
value
• Ex: Company hires lawyer to represent the
company. The services are for $25,000. In
return, the lawyer accepts 2,500 shares of $1 par
common stock with $10/share market value.
JOURNAL
Date Accounts and explanation Debit Credit
Legal expense 25,000
Ordinary Shares 2,500
Paid-in capital in excess of par 22,500

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Preference Shares
• Follows same pattern as accounting for ordinary
shares
• May have separate accounts for paid-in capital in
excess of par for preferred shares
• Can be issued with conversion feature
▫ Allows preferred shareholders to exchange
preferred shares for ordinary shares

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Number of Shares

Authorized Issued

Outstanding

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Number of Shares
• Authorized
▫ Total number of shares the company is permitted
to offer (registered with government)
▫ http://www.cr.gov.hk/en/faq/faq05_c.htm(Q4 &
Q9)
• Issued
▫ Number of shares sold to shareholders
• Treasury Shares
▫ Shares purchased back by the company after
issuing
• Outstanding
▫ Number of shares sold and not redeemed or
cancelled
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Learning Objective Three
Describe how treasury shares affects a company

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Treasury Share
• Issued shares reacquired by the company
• Reasons:
▫ Make shares available for employee share
purchase plans
▫ Plan to “buy low” and “sell high”
▫ Avoid takeover
▫ Increase earnings per share

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 Recording Treasury Share
• Recorded at cost
▫ Not par value
• Classified as a contra-shareholders’ equity
account
▫ Debit balance
• Example: repurchase 500 shares for $2,000
JOURNAL
Date Accounts and explanation Debit Credit
Treasury shares (X-Eq) 2,000
Cash 2,000
Purchased treasury shares

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 Issuing shares
grows assets and
equity

Purchasing
treasury shares
shrinks assets and
equity
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 Resale of Treasury Shares
• If a company subsequently re-sells treasury
shares, DR cash received and CR treasury shares
sold. Difference goes into paid-in capital (or
share capital) account.
• Example: resell 500 treasury sells for $3,000
• Note: Never record gain/loss on treasury shares
JOURNAL
Date Accounts and explanation Debit Credit
Cash 3,000
Treasury Shares (- X-EQ) 2,000
Paid-in capital from treasury share transactions 1,000
To record resale of treasury shares
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 Issuing Treasury Shares as
Compensation
• Many companies repurchase shares to
compensate employees.
• Stock option compensation is a complicated
issue, we will not cover the details in this class
JOURNAL
Date Accounts and explanation Debit Credit
Share Option Compensation (expense) 10,000
Treasury Shares (- X-Eq) 10,000
To record reissuance of treasury shares

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 Retiring Treasury Shares
• Some companies retire/cancel shares after
repurchasing them.
• Reduce the Share Capital account by the amount
of Treasury Shares
• Example: retire $33,347 of treasury shares
JOURNAL
Date Accounts and explanation Debit Credit
Share Capital (- Eq) 33,347
Treasury Shares (-X-Eq) 33,347
To record reissuance of treasury shares

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Example: Exercise 10-24A
• Record the Journal Entries for the following
transactions:
▫ Jan 17: Issued 2,200 shares of $2.50 par ordinary
shares at $10 per share.
▫ May 23: Purchased 300 shares of treasury shares at $12
per share.
▫ Jul 11: Sold 200 shares of treasury shares at $20 per
share.
• Show the effects on shareholders’ equity

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 Exercise 10-24A
JOURNAL
Date Accounts and explanation Debit Credit
17 Jan Cash 22,000
Ordinary Shares 5,500
Paid-in capital in excess of par 16,500

23 May Treasury shares (300 shares at $12) 3,600

Cash 3,600

11 Jun Cash 4,000

Treasury shares (sell 200 shares) 2,400
Paid-in capital - treasury shares transactions 1,600

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Exercise 10-24A
Effect on Shareholders’ Equity
17 Jan Ordinary shares issued $22,000
23 May Purchase of treasury shares (3,600)
11 Jun Sale of treasury shares 4,000
Total change $22,400

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Retained Earnings

Cumulative Dividends
Net losses
Net income declared

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Retained Earnings Balance

Credit
Lifetime
balance = Lifetime
Retained earnings > losses &
dividends
Earnings

Debit balance
Lifetime
= Lifetime
Accumulated earnings < losses &
dividends
Loss
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Learning Objective Four
Account for dividends

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Cash Dividends
• Company must have both:
▫ Enough Retained earnings to declare the dividend
▫ Enough Cash to pay the dividend
▫ DR Dividend
▫ CR Cash or Dividend Payable
• Two types of dividends:
▫ Interim dividends
 Declared during the year
 Declared by board of directors
▫ Final dividend
 Declared after the end of financial year and company’s AGM
 Recommended by board of directors and require approval by
shareholders

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Dividend Dates
• There are three relevant dates for dividends:
▫ 1. Declaration date:
 The board of directors announces the dividend. If it is for an
interim dividend, the declaration of the dividend creates a
liability for the corporation. If it is for a final dividend, it will
have to be approved by shareholders at the AGM.
▫ 2. Date of record:
 The shareholders on the record date will receive the dividend on
the payment date. There is no journal entry for the date of record.
▫ 3. Payment date:
 Payment of the dividend usually follows the record date by a
week or two. Payment is recorded by debiting Dividends payable
and crediting Cash.

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Dividend Dates
1. Declaration date
JOURNAL
Date Accounts and explanation Debit Credit
Dividend->Retained earnings
Dividends payable

2. Date of record No entry

3. Payment date
JOURNAL
Date Accounts and explanation Debit Credit
Dividends payable
Cash
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Dividends on Preference Shares
• Paid dividends before common shareholders
• Stated as a percent of par value or a dollar amount per
share
▫ Ex: 6% preference shares means 6% of par value. $1
preference shares means $1 dividend
• May be cumulative (cumulative dividends must be paid
to preferred S/H before dividends paid to common S/H)
▫ Passed dividends are owed to preference shareholders,
called dividends in arrears
▫ Paid before other dividends
▫ Almost like debt

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Exercise 10-28A
• Facts
▫ Preference share, cumulative, $0.50 par, 9%, 40,000 shares
issued
▫ Ordinary shares, $0.10 par, 9,170,000 shares issued
▫ Huron Manufacturing has paid all preferred dividends through
2007.

• Requirement
▫ Compute the total amounts of dividends to both preference
and ordinary for 2010 and 2011, if total dividends are $60,000
in 2010 and $120,000 in 2011.
Note: Typo in textbook, asks for 20X6 and 20X7

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Exercise 10-28A
Preference dividend = $0.50 x 9% x 40,000
shares
$1,800
Preferred Common
2010 - $60,000
Dividends in arrears (2 years x 1,800) $3,600
Current year 1,800
5,400
Remainder to ordinary $54,600
2011 - $120,000
Preference – current year 1,800
Remainder to ordinary 118,200
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Share Dividends
• Proportional distribution of shares to shareholders
• Increase Share Capital account and decrease Retained
Earnings
▫ Total equity is unchanged
• Reasons share dividends are distributed
▫ Continue dividends, but conserve cash
▫ Reduce market price of shares
• Example: Declare a 10% dividend with 1,000 outstanding
shares valued at $1 per share
▫ Journal Entry
 Debit Retained Earnings 100
 Credit Share Capital 100

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Stock Splits
• Sometimes, a company will “split” its shares, for
example, a 2-for-1 split
▫ Increase in shares with a proportionate reduction
in par value
▫ Decreases market price of shares
• No accounts affected (in total)
▫ Par value per share halved
▫ Shares authorized double
▫ Shares issued double

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 Effect on Total:
Shareholders
Transaction Assets = Liabilities + ’ Equity
Issuance of share Increase No effect Increase
Purchase of
treasury share Decrease No effect Decrease
Sale of treasury
share Increase No effect Increase
Declaration of
cash dividend No effect Increase Decrease
Payment of cash
dividend Decrease Decrease No effect
Share dividend No effect No effect No effect
Stock split No effect No effect No effect

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Learning Objective Five
Use share values in decision making

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Share Values
Market value • Price of a share in the market

Redemption • Price a company agrees to pay on

value redemption of the share

Liquidation • Amount paid to a preference

value shareholder during liquidation

• Amount of owner’s equity on the

Book value company’s books

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Learning Objective Six
Compute earnings per share and return on
equity

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Earnings Per (Common) Share
Net Income
Available to
Net income – Preference Common
Shareholders
Dividends

Average number of (Common)

shares

(Beginning total shares + Ending total shares)/2

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Return on Equity (RoCE)

Net income – Preference dividends

Average ordinary shareholders’ equity

(Beginning ordinary shareholder equity+ Ending ordinary shareholder

s’equity)/2

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Learning Objective Seven
Report equity transactions on the statement of
cash flows

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Equity Transactions on the Cash
Flow Statement (somewhat
discretionary)
Consolidated Cash Flow Statement
Cash flows from operating activities $XXX
Cash flows from investing activities XXX
Cash flows from financing activities
Payment for share issuance costs (XXX)
Payment for repurchase of shares (XXX)
Proceeds from issuance of shares XXX
Dividends paid (?) (XXX)
XXX
Net cash flows XXX

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Announcements
• No class next two weeks (Reading Week, Good
Friday, Easter, and Ching Ming)
▫ Tuesday: Mar 27 and Apr 3
▫ Thursday: Mar 29 and Apr 5

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