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Shareholders equity

Accounting (Chapter 11)

Learning objectives
LO1: Describe the characteristics of the corporate form of business.
LO2: Describe the characteristics of equity and how it is recorded and
reported.
LO3: Understand cash dividends, share dividends and share splits.
LO4: Describe the characteristics of preference shares and preference
dividends.
LO5: Describe the characteristics of share buybacks and how they are
recorded and reported.

LO1 Companies
Describe the characteristics of the corporate form of
business.
The corporate form of business has the following characteristics:
Separate legal entity
ability to raise capital
limited liability of owners
transferability of ownership
dividend imputation
regulation.

Separate legal entity


A company (corporation) is a separate legal entity.
The Australian Securities and Investments Commission (ASIC)
registers companies and each is given an Australian Company
Number (ACN).
Only a very small proportion of companies are publically traded on the
Australian Securities Exchange (ASX).

Ability to raise capital


The ability to access capital through the sale of share is an advantage
of the corporate form of business.
But the vast majority of companies do not list on the ASX and are
restricted from raising capital, from the public.
They are also limited in raising capital because lenders know they are
unable to raid the personal assets of the owners (shareholders).

Limited liability of owners


Sole proprietors and partnership owners are personally liable for the
actions and obligations of their businesses.
Shareholders normally have no personal liability for the corporations
obligations beyond their investment in shares.
Limited liability is a major advantage of the company form of business
and is credited with the growth of business post the industrial
revolution.

Transferability of ownership
Another advantage of the corporate form of business is the ease with
which ownership can be transferred, especially shares in publically
listed companies (what you hear about on the news when CBA shares
sell for $60).
When one sole proprietor wants to transfer ownership to another, the
business must be sold.
When a partner wants to transfer an ownership, usually all other
partners must agree.

Dividend imputation
Unlike many countries, Australia does not have double taxation of company
income.
When a corporation is taxed on income, the tax paid is imputed to shareholders
with dividends.
Imagine a company earned $10 000 taxable income and paid $3 000 tax (30%
company tax rate). They then pay the remaining $7 000 in dividends to
shareholders. Assume one shareholder received all the dividends they have the
equivalent pre-tax profit ($10 000) added to their personal income, and pay tax on
that $10 000 at their personal tax rates However, they receive a credit for the $3
000 tax already paid by the company. In this way, we minimise double taxation.

Regulation
Limited liability companies have more regulation.
Publicly traded companies are required to file numerous reports with
ASIC and have their annual report audited.
Companies trading on the ASX are also subject to the continuous
disclosure regime.
Following the Corporate Law Economic Reform Program (CLERP9),
even more disclosures were required by ASIC.

LO2 Shares
Describe the characteristics of equity and how it is
recorded and reported.
One of the distinguishing characteristics of a company is its
ability to sell capital (shares) to investors to raise funds. The
amount raised by issuing capital share is called contributed
capital because the funds are contributed by investors in
exchange for an ownership claim on company assets.

Shareholders rights
When a corporation issues (ordinary) shares, it usually grants
shareholders the following rights:
the right to vote
the right to participate proportionally in dividends
the right to participate proportionally in residual assets (mainly relevant
if company is wound up)
the right of preemption (maintain the same proportion of ownership in
the company).

Issuing shares
Assume that a company issues 100 shares for $5 per share.
The issue will be recorded as follows:

Instalment share issues


Why issue shares that require payment in instalments?
A function of the process to ensure only serious applicants submit requests
for shares, and their intention is signalled by an initial payment (instalment).
Receive capital over time, not all immediately (e.g. funds for a long term
project. you may not need it all today, but want to know the money is
coming)
Increase the pool of relevant shareholders affordability

How do you do it?


Issuing shares by installment
Typically, we first require payment on application by shareholders, then
when we confirm that people will receive their shares, making them
shareholders (allotment). Finally, we may require future payments as and
when required (call)
Assume that a company issues 100 shares for $5 per share, $2 payable on
application (5 Apr), $1 payable on allotment (by 15 Apr), and $2 on a future
call (20 June). The following would be recorded when the application
money is received on 5 April:

Issuing shares by installment (2)


Once the shares are allotted (10 April) the cash becomes the companys
and the cash can now come out of the trust.

Issuing shares by installment (3)


When the allotment money is received on 15 April:

There is no need to increase equity as this was recognised on 10 April


when the shares were allotted.

Issuing shares by installment (4)


A call is made on 20 June, with payment due by 30 June.:

Ledger Accounts
Consider what the ledger accounts (t-accounts) would look
like at the end of the process.
Only Cash and Contributed Capital should have a positive balance.
All other accounts should equal 0
Check if you have made a mistake. Application, Allotment, Call accounts
should all balance out to 0 by the end of the process.

Consider what the Balance Sheet would look like at the end
of the process.
Assets = Cash
Equity = Contributed Capital

Other issues in share instalment process


please see ScreenCast video!
Too many applications, not enough shares to issue
What do you do with the extra applications? The OVER-SUBCRIPTION problem
You either refund the cash from extra applications back to shareholders, or you
keep it and use it to off-set (reduce) they required payments on future instalments
(e.g. allotments, or calls).

Shareholders dont pay their instalments


Forfeit their shares
Re-issue them to new shareholders, often at a discount
Given old shareholders their monies from previous instalments back, less the
discount suffered for having to reissue it.

LO3 Dividends
Understand cash dividends, share dividends and
share splits.
The goal of any corporation is to generate profits. Once
generated, a company must decide whether or not to distribute
those profits to its owners through dividends. A dividend is a
distribution of profits to owners. A cash dividend reduces the
cash available to pursue other strategies.

Dividends (2)
Dividends are normally paid in cash, but they can also be paid in other
forms such as shares.
When dividends are distributed, they are stated as a per share amount
and are paid only on issued shares.
When and how a company distributes dividends is called a companys
dividend policy.

Cash dividends
The date the board declares the dividend is called the date of
declaration. On this date, the board legally obligates the company to
pay the dividend, so a liability is created.
The boards declaration will also include the payment date and the
date of record. The payment date is the date on which the dividend will
be distributed.
The shares owner on the date of record receives the dividend.

Recording cash dividends


Assume that a company with 1 000 000 shares declares a $0.05 per
share dividend on 3 November. The dividend is payable on
30 November to shareholders of record on 21 November.

Note how the date of record (21 Nov) has no accounting effect

Reporting cash dividends


Companies usually report their dividends on two financial statements:
Dividends declared during the year are reported on the statement of
changes in equity.
Dividends paid during the year are reported on the statement of cash
flows. Because dividends are cash outflows, they are shown as
negative numbers in the financing section.

Share dividends
A share dividend is a distribution of a companys ordinary share to
existing shareholders.
Share dividends are declared by a companys board of directors and
may be stated in percentage terms.
E.g. a 10 per cent share dividend means that the company will issue
additional shares equal to 10 per cent of the current issued shares.
So, an investor owning 10 000 shares will receive 1 000 additional
shares (10 000 X 10%).
No cash outflow for the company!

Recording share dividends


Assume that Bethany Ltd declares a 15 per cent share dividend on
1 June to be distributed immediately. On 1 June, Bethany has 100 000
ordinary shares originally issued for $1 and the share is trading at
$10 per share.

Share splits
When a company wants to decrease the market price of its share to make it more
affordable, it can use a share split instead of a share dividend.
A share split is an increase in a companys share according to some specified
ratio.
E.g. a company that declares a 2-for-1 split recalls all shares from existing
shareholders and issues two shares in return, effectively doubling the shares
issued. As result of this increased supply of shares, the market price of the share
usually falls proportionally. In a 2-for-1 split, the share price would be cut in half.
This sometimes does not happen, for behavioural finance reasons!
Is it more likely that a $50 share goes up to $55, or a $1.00 share goes up to $1.10? You
may say the latter, but finance says both are theoretically, equally likely!

LO4 Preference shares

Describe the characteristics of preference share and how it


receives preference in dividends.
Preference share are a form of shares that receives one or
more priorities over ordinary share. Usually, preferred
shareholders relinquish the right to vote in exchange for
preference to dividends and preference to assets upon
liquidation of the company

Recording preferred share


Assume a company issues 500 shares for $15 per share on 23 August.

Cash dividends on preferred share


When a company has both preferred and ordinary shares outstanding,
cash dividends must be allocated between the two:
Cumulative preferred shares carry the right to receive current-year
dividends and all unpaid dividends from prior years before dividends
are paid to ordinary shareholders.
Dividends in arrears are the accumulated value of unpaid prior-year
dividends.
Noncumulative preferred shares carry the right to receive current-year
dividends only (before ordinary shareholders in the current year).

Recording dividends declared


Stover, Ltd has the following types of share:
Ordinary share, 100 000 shares
5%, $10 Cumulative Preference share, 20 000 shares
Stover does not pay dividends in 2011 or 2012 but declares $64 000
of dividends in 2013.

LO5 Share buybacks


Describe the characteristics of share buybacks and how
they are recorded and reported.

Share buybacks are both a way to reduce the number of shares


(and changing the earnings per share calculation) and a tax
effective way to return capital (it could be thought of as a
liquidating dividend) to some shareholders.

Recording share buyback


Bajada Limited purchases 1 000 shares of its own ordinary shares on
3 May when the share is trading for $32 per share. Bajada would record
the buyback as follows:

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