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CHAPTER 15
Equity
LEARNING OBJECTIVES
1. Discuss the corporate form and the issuance of shares.
2. Explain the accounting and reporting for treasury shares.
CHAPTER REVIEW
1. Chapter 15 focuses on the equity section of the corporate form of business organization.
Equity represents the amount contributed by the shareholders and the portion that was
The Corporate Form
2. (L.O. 1) The corporate form of business organization generally begins with the submitting
of articles of incorporation to the appropriate governmental agency in the country in
which incorporation is desired. While a company can operate in many different countries,
3. Within a given class of shares, each share is exactly equal to every other share. A
person’s percent of ownership in a corporation is determined by the number of shares he
4. The transfer of ownership between individuals in the corporate form of organization is
accomplished by one individual selling or transferring his or her shares to another
5. The basic ownership interest in a corporation is represented by ordinary shares. Ordinary
shares are guaranteed neither dividends nor assets upon dissolution of the corporation.
Equity
6. Equity in a corporation is the residual interest in the assets of the company after
deducting all liabilities. Equity is often subclassified, and the following categories are
commonly used.
a. Share capital.
Equity: Contributed Capital and Earned Capital
7. Contributed capital is the amount paid in by shareholders and includes par value and any
premiums (less any discounts). Earned capital or Retained Earnings results from the
Accounting for the Issuance of Shares
9. The process for issuing shares begins with authorization by the appropriate governmental
agency to issue shares (often the corporate charter), next the corporation offers the
10. When par value shares are issued, the Share Capital (Ordinary or Preference) account
is credited for an amount equal to par value times the number of shares issued. Any
amount received in excess of par value is credited to Share Premium. For example, if
11. When no-par shares are issued, the Share Capital account is credited for an amount
equal to the value of the consideration received. Some no-par shares have a stated
Lump Sum Sales
12. More than one class of shares is sometimes issued for a single payment or lump sum
amount. Such a transaction requires allocation of the proceeds between the classes of
Shares Issued in Noncash Transactions
13. Shares issued for consideration other than cash should be recorded using the fair value of
the consideration received. If that fair value cannot be measured reliably, the fair value of
the shares issued should be used. In cases where the fair market value of both items is
the Board of Directors abuses this power, watered shares or secret reserves can result.
Costs of Issuing Shares
14. Direct costs incurred to sell shares such as underwriting costs, accounting and legal fees,
and printing costs should be recorded as reductions of amounts paid in (debited to Share
Preference Shares
15. Preference shares is the term used to describe a class of shares that possesses certain
preferences or features not possessed by the ordinary shares. The following features are
those most often associated with preference share issues:
a. Preference as to dividends.
Some features used to distinguish preference shares from ordinary shares tend to be
restrictive. For example, preference shares may be nonvoting, noncumulative, and
nonparticipating. A corporation may attach whatever preferences or restrictions in
16. Certain terms are used to describe various features of preference shares. These terms
are the following:
a. Cumulative. Dividends not paid in any year must be made up in a later year before
paying any dividends to ordinary shareholders. Unpaid annual dividends on cumu-
lative preference shares are referred to as dividends in arrears and are disclosed in
a note to the financial statements.
Reporting of Preference Shares
17. Preference shares generally have no maturity date and therefore no legal obligation
Treasury Shares
18. (L.O.2) Treasury shares are a corporation’s own shares that (a) were outstanding, (b)
have been reacquired by the corporation, and (c) are not retired. Treasury shares are not
19.Two methods are used in accounting for treasury shares, the cost method and the par
value method. The par or stated value method records all transactions in treasury shares
at their par value and reports the treasury shares as a deduction from share capital only.
Under the cost method (the method most frequently used), treasury shares are recorded in
the accounts at acquisition cost. When the treasury shares are reissued, the Treasury
10,000 ordinary shares with a par value of £5 per share were originally issued at £12 per
share.
A. 2,000 ordinary shares are reacquired for £20,000.
Entry for Purchase
20. The Board of Directors may approve the retirement of treasury shares. When this occurs,
the treasury shares are cancelled, the number of issued shares is reduced, and the
retired treasury shares have the status of authorized and unissued shares.
Dividends
21. (L.O.3) Very few companies pay dividends in amounts equal to their legally available
retained earnings. The major reasons are: (a) agreements with creditors, (b) corporation laws
23. Dividends may be paid in cash (most common means), shares, or some other asset.
Dividends other than a share dividend reduce the equity in a corporation through an
Cash Dividends
24. The accounting for a cash dividend requires information concerning three dates: (a) date
of declaration, (b) date of record, and (c) date of payment. A liability is established by
a charge to retained earnings on the declaration date for the amount of the dividend
Declaration Date (March 10)
Retained Earnings (or Cash Dividends Declared) ..... 50,000
Dividends Payable ............................................... 50,000
Record Date (March 25)
No entry
Property Dividends
25. Property dividends, or dividends in kind, represent distributions of corporate assets other
than cash. Such transfers should be recorded at the fair value of the assets
transferred. When the property dividend is declared, fair value should be recognized in
the accounts with the appropriate gain or loss recorded. The fair value then serves as the
Liquidating Dividends
26. Liquidating dividends represent a return of the shareholders’ investment rather than
Share Dividends
27. When a company issues a share dividend, no assets are distributed and each
shareholder has exactly the same proportionate interest in the company before and after
28. When a share dividend is declared, Retained Earnings is debited for the number of
shares issued times their par value and Ordinary Share Dividend Distributable is credited
for the same amount. A share dividend is recorded at par value and does not affect any
asset or liability accounts. If a statement of financial position is prepared between the
When the shares are issued, the entry is:
Ordinary Share Dividend Distributable ....................... 50,000
Share Capital—Ordinary ...................................... 50,000
Share Split
29. A share split results in an increase or decrease in the number of shares outstanding with
a corresponding decrease or increase in the par or stated value per share. In general, no
accounting entry is required for a share split, as the total dollar amount of all equity
Presentation and Analysis of Equity
30. (L.O.4) In many corporations restrictions on retained earnings or dividends exist, but no
formal journal entries are made. Such restrictions are best disclosed by note.
31. An example of a comprehensive equity section taken from a statement of financial position is
32. IFRS requires companies to present a statement of changes in equity that includes the
following:
a. Total comprehensive income for the period, showing separately the amounts
33. Several ratios use shares equity related amounts to evaluate a company’s profitability and
long-term solvency. The following three ratios are discussed and illustrated in the chapter:
(1) rate of return on ordinary shares equity, (2) payout ratio, (3) book value per share.
Rate of Return
Dividend Preferences
*34. (L.O.5) Preference shares generally have a preference in the receipt of dividends.
Preference shares can also carry features that require consideration at the time a
dividend is declared and at the time of payment. These features are (a) the cumulative
feature, and (b) the participating feature. The text material includes computational
LECTURE OUTLINE
The material in this chapter is straightforward and can be covered in two class sessions. Treasury
A. (L.O.1) The corporate form.
1. The primary forms of business organization are the proprietorship, the partnership, and
3. Share system—Each share represents an ownership right with the following privileges:
a. To share proportionately in profits or losses.
4. Variety of ownership interests.
a. Ordinary shares: The residual corporate interest that bears the ultimate risks
B. Corporate Capital.
2. The two primary sources of equity are:
C. Accounting for the Issuance of Shares.
1. Par value shares.
2. No-par shares. The issuance of such shares avoids any contingent liability and also
prevents par value from being used as a basis for fair value. In some cases, no-par
shares are given a stated or minimum value.
4. Noncash share transactions. Shares issued for consideration other than cash should
5. Costs of issuing shares. These costs are treated as a reduction of the amounts paid
in and debited to Share Premium.
D. Preference Shares: Usually issued with a par value. Sometimes, preference shares have
more debt characteristics than equity characteristics. Preference shares are a special class
of shares that may carry a variety of features or preferences including:
1. Preference as to dividends. Preference shareholders are paid before ordinary
shareholders.
a. The dividend is expressed as a percentage of par value or as a specific dollar amount.
2. Preference as to assets in the event of liquidation.
3. Convertible into ordinary shares.
E. (L.O.2) Reacquisition of Shares.
1. Corporations may buy their own shares for a variety of reasons.
a. To provide tax efficient distributions of excess cash to shareholders.
2. Treasury shares are not an asset. Treasury shares do not vote, receive dividends, or
3. Treasury shares are most often accounted for using the cost method.
a. The cost method results in debiting the Treasury Shares account for the
reacquisition cost.
(1) Sale of Treasury Shares above cost. The difference is credited to Share
(2) Sale of Treasury Shares below cost. The difference is debited to:
(3) Retiring Treasury Shares. Retired treasury shares have the status of
F. (L.O. 3) Dividend Policy.
1. Few firms pay out dividends in amounts equal to their retained earnings available for
3. Financial condition of the firm: Before dividends are declared, the availability of funds
to pay the dividend should be considered.
G. Types of Dividends.
1. Cash dividends. Once declared, a dividend (except a share dividend) is a liability
(usually current). Dividends are not declared and paid on treasury shares.
4. Share dividends. No assets are distributed and each shareholder retains the same
proportionate interest in the corporation. When a share dividend is declared by the
H. (L.O.4) Presentation and Analysis of Equity.
1. Presentation.
a. On the statement of financial position—companies normally disclose:
(1) Share capital.
b. IFRS requires companies to provide a statement of changes in equity that includes:
(1) Total comprehensive income for the period.
c. Disclosures related to shares equity include dividend and liquidation preferences,
participation rights, call prices, and dates.
2. Analysis. Several ratios use equity amounts to evaluate a company’s profitability and long-
term solvency.
Trading on the equity at a gain: practice of borrowing money or issuing
preference shares in hopes of obtaining a higher rate of return on the
money used.
I. (L.O.5) APPENDIX 15A. Dividend Preferences and Book Value per Share.
1. Dividend preferences.
a. Preference shares are noncumulative and nonparticipating.
2. Book value per share.
a. In simplest form:
Net Assets
Outstanding shares at end of year
b. Complications may occur if preference shares exist. For example:
(1) Preference dividends are in arrears.
