Intermediate Accounting

13th Canadian Edition, Volume 2

Kieso ● Weygandt ● Warfield ● Wiecek ● McConomy

Chapter 15
Shareholders’ Equity
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Chapter 15: Shareholders’ Equity
After studying this chapter, you should be able to:
1. Discuss the characteristics of the corporate form of
organization, rights of shareholders, and different types of
shares.
2. Explain how to account for the issuance, reacquisition,
and retirement of shares, stock splits, and dividend
distribution.
3. Understand how shareholders’ equity is presented,
disclosed, and analyzed.
4. Identify differences in accounting between IFRS and ASPE,
and what changes are expected in the near future.

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Primary Forms of Business Organization
• Three primary forms of business organization
o Proprietorship, partnership, corporation
• Most common for mid-size to large companies is the
corporate form
• Advantages of the corporate form
o Separate legal entity
o Greater legal protection
o Involves the issue of shares—access to capital markets

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Classification of Corporations
• Corporations are classified by the nature of ownership
• Public Sector Corporations
o Government Units: Municipalities, Cities (No shares issued)
o Government Business Enterprises: Post Office, Liquor Control
Boards (Share or shares issued)
• Private Sector Corporations
o Not-for-Profit: Churches, Charities (No shares issued)
o For Profit: (Shares Issued)
• Private Companies: shares are held by a few shareholders; not
available for public purchase; bound by shareholder agreements
• Public Companies: shares are available for purchase by the public
through stock market; bound by securities and corporate laws
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Corporate Law and the Share Capital
System: Incorporation
• Submit articles of incorporation (provincial or federal)
o Company name, place of registered office
o Classes, maximum number of shares authorized
o Restrictions on share transfers
o Number of directors
o Restrictions on corporation’s business
• Requirements fulfilled—charter is issued and corporation is
recognized as a legal entity
• Corporation prepares share certificates and issues to the
shareholders
• Legal aspects of this chapter consider only the CBCA
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Corporate Law and the Share Capital
System: Shares
• Usually share capital consists of a large number of units
o Shares are organized into groups or classes
o Within a class, each share is exactly equal to every other
share
o Number of shares held determines owner’s interest
• If no restrictions, each share gives basic or inherent rights
to share proportionately in
o Profits and losses
o Management (vote for directors)
o The corporate assets upon liquidation
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Corporate Law and the Share Capital
System: Advantages
• Discretionary right called the pre-emptive right
o Share proportionately in any new issues of the same class
o Protects from involuntary dilution
o Eliminated by many corporations
• Advantage of the share system is the ease of
transferability of ownership
• Shares are owned personally, and owner may sell at any
time or at any price
• Corporation obligation: keep a list of shareholders

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Types of Shares: Common Shares
• Represents the basic ownership interest
• Carry the residual risks and rewards of ownership
• A common shareholder is not guaranteed
o Annual dividends
o Assets upon dissolution
• Generally, common shareholders can
o Elect Board of Directors through the voting rights
o Profit the most if the company is successful
• If only one issue of capital shares—common shares

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Types of Shares: In-Substance Common
Shares
• An investment with risk and rewards characteristics that are
substantially similar to the common shares but not called common
shares for legal purposes
• Making the distinction directs the accounting treatment
• Deciding whether to treat financial instruments as common shares,
consider
o Subordination
o Risks and rewards of ownership
o Obligation to transfer value
o No other common shares
o Redemption
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Types of Shares: Preferred Shares
• Rights may be sacrificed in return for other special rights
or privileges
• Special class with preferential rights (preferred shares)
o Priority claim on earnings and assets upon dissolution or
windup
o Assurance of a dividend before common shares
o Rank ahead of common shares for getting investment
returned in case of bankruptcy
• Generally, preferred shareholders sacrifice
o Voting rights
o A right to share in profit beyond the stated rate
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Dividend Preferences for Preferred
Shares
• Preferred shares may be issued with a dividend
preference expressed as a
o Percentage of the issue price (8% preferred shares)
o Specific dollar amount per share ($8 per share)
• A preference does not assure dividends will be paid
• Means the stated dividend rate or amount must be paid
before any dividends can be paid on the common shares
• Preferred shares issued instead of debt to lower the debt-
to-equity ratio

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Features of Preferred Shares
• Some preferred share features:
o Cumulative—dividends in arrears; must be paid before any
profits can be distributed to common shareholders
o Convertible—exchange for common shares
o Callable/Redeemable—issuing corporation can call or
redeem at specified dates and prices
o Retractable—shareholders can sell their shares to the
company and the company must pay
o Participating—share in profit distributions above the stated
rate

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Limited Liability of Shareholders
• Liability is limited to the amount invested
• Unlike partnership or proprietorship, creditors have no recourse
against the personal assets of shareholders
• Shareholder investment cannot be withdrawn unless all prior claims
have been paid—corporation must maintain capital until dissolution

All proceeds credited

According to the to the share capital
account; become part Where allowed,
CBCA, shares must be of the shareholder’s establishes maximum
without a nominal or investment responsibility in case of
par value insolvency
Par value is not a “value”. It is simply an amount
assigned to each share.
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Legality of Dividend Distribution
• Profit distribution (dividends) is controlled by certain legal
restrictions
• Not all shares carry the right to receive dividends
• No distribution unless capital is intact
• Under CBCA, dividends may not be declared or paid if
grounds to believe that after the dividends are paid
o Corporation is unable to pay liabilities
o Realizable value of assets becomes less than liabilities plus
legal capital
• Distributions formally approved by the board
• Dividends must agree with stipulations in the contracts

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Financial Condition and Dividend
Distribution
• Reasons few companies pay dividends with all legally
available retained earnings
o Agreements or covenants with creditors to retain assets as
protection against loss
o Retain assets in order to finance growth
o Smoothing over years—fund dividends in both good and
bad years
o Build a cushion or buffer against possible losses
• Distribution justified by present and future financial
position; considering economic conditions, inflation,
replacement costs and liquidity

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Recognition, Derecognition and
Measurement: Issuance of Shares
• Shares are sold for the price in the marketplace
o The net amount received is credited to common or
preferred shares
• Lending money to employees to buy shares; risk of
collection is often very high
• Under conceptual framework—present receivables as a
reduction of shareholders’ equity unless
o Evidence the shares will not decline in value
o Assurance the amount will be collected

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Shares Sold on a Subscription Basis
• Full price is not received immediately
o Partial payment is made; paid in installments
o Share is not issued until full price is received

Share subscription:
Individuals given right
to purchase 10
common shares at $20
per share; 50 people
accept; pay 50% down,
balance in 6 months After first payment is received balances are:
Share Subscriptions Receivable, $5,000
Common Shares Subscribed, $10,000

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Final Instalment on Share Subscriptions
• Based on professional judgement, Share Subscriptions
Receivable account can be
o Presented as an asset
o Reported as a contra equity account (conceptually preferable)

After second payment,

balances are:
Share Subscriptions Receivable, $0
Common Shares Subscribed, $0
Common Shares, $10,000

Shares are not issued until

total payment is received

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Defaulted Subscription Accounts
• If a subscriber defaults
o Refund the amount already paid
o Treat amount paid as forfeited; transfer to contributed
surplus
o Issue fewer shares
See previous example:
Assume subscribers to 50
of the $20 shares
defaulted. Also assume
amounts are refunded.

If the Accounts Payable amount of $500

was forfeited, there would be a $500
credit to Contributed Surplus

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Shares Issued with Other Securities (Lump-
Sum Sales)
• Generally, corporations sell each class separately to
determine proceeds of each class individually
• It does happen—more than one type or class can be
issued (e.g., acquisition of another company)
• Lump-sum sale: proceeds must be allocated among the
separated classes of securities
o Relative fair value—uses fair values to proportionally
allocate proceeds
o Residual fair value: value one instrument—then allocate
the rest
• Method also covered in Chapters 6, 8, 10, and 16

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Cost of Issuing Shares
• Direct incremental costs incurred to sell shares deducted from
the proceeds
o Underwriting costs
o Accounting and legal fees
o Printing costs
o Taxes
• Issuing costs charged to the related Shares account because
they are a capital (not operating) transaction
• Management salaries and other direct costs-–expensed as they
occur
• Annual costs for maintaining records—normally charged to
expense when they occur

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Reacquisition, Retirement, and
Conversion of Shares
• Not unusual for companies to buy back their shares to
o Increase earnings per share and return on equity
o Provide shares for employee share compensation contracts
o Have them available for business acquisitions, mergers
o Stop takeover attempts by reducing the number of shareholders
o Create a demand to affect share price
o Return cash to shareholders
o Take a public company private
o Manage regulatory capital requirements
• Leveraged buy-out: management or employee group
purchases shares; company assets used as collateral

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Reacquisition of Shares
• Once shares are reacquired, they can be
o Retired
o Held as treasury shares—intended for re-issue (in some
jurisdictions)
• In Canada, the CBCA requires repurchased shares to be
cancelled, and restored to status of authorized but
unissued if a limit to the number of authorized shares
exists
• Treasury shares relatively uncommon in Canada
• When shares are purchased or redeemed, likely the price
paid will differ from the amount originally received
• Capital transaction—gain or loss booked through equity

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Allocation of Reacquisition Costs
• If acquisition cost > original amount received, allocate
o First, to share capital in amount = par, stated, or assigned
value; then, to Contributed Surplus; last, to Retained
Earnings
• If acquisition cost < original amount received, allocate
o First, to share capital in amount = par, stated, assigned
value; then, to Contributed Surplus
• For shares with no par value
o Assigned value = average per share amount for the class of
shares on transaction date
o Difference between assigned value and lower cost of
acquisition: credited to Contributed Surplus
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Share Buyback
PiP 15.5 Facts: Cooke Corporation has the following in its shareholders’ equity
accounts

• On January 30, Cooke purchased and cancelled 500 Class A

shares at a cost of $4 per share.
• On September 10, the company purchased and cancelled an
additional 1,000 Class A shares. The purchase cost was $8 per
share.
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Accounting for a Share Buyback
Journal Entry
Jan 30

*Excess of assigned amount over reacquisition cost = ($6 - $4) x 500 Shares
Journal Entry Sept 10

1 : allocate to share
st
*2 : net excess of
nd 3rd: any remaining to
Retained Earnings
capital the assigned proceeds from
value = $6.00/share previous cancellation

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Accounting for a Share Conversion
PiP 15.6 Facts A company has 1,000 convertible preferred shares
outstanding with a carrying value of $100,000. The shares are
convertible to common shares based on 10 preferred shares for
every common share.

Journal Entry for

Conversion

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Dividends
• Basically, two classes of dividends
o Return on capital (share of the earnings)
o Return of capital (liquidating dividends)
• Dividends reduce shareholders’ equity
• A declared dividend is a liability
• Declared as a % of stated value or an amount per share
• Dividends are not paid on treasury shares
• Three important dates:
o Date of declaration (resolution passed by board)
o Date of record (eligible shareholders)
o Date of payment

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Dividends—Cash Dividends
PiP 15.7 Facts: On June 10, a corporation declared a cash dividend of 50
cents a share on 1.8 million shares payable on July 16 to all shareholders
of record on June 24.
• First journal entry is on the declaration date (June 10)
Could also debit Retained
Earnings; Dividends keeps a
separate record, but is still
closed to Retained Earnings

• No entry on the date of record

• The liability is cleared on the payment date (July 16)

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Dividends—Dividends in Kind
• Dividends that are payable in corporation assets other
than cash
• Non-reciprocal transfer of nonmonetary assets between
an entity and its owners
• May be merchandise, real estate, investments
• Usually is the form of securities of other companies
• Generally measured at the fair value of the asset given up

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Dividends—Stock Dividends
• Capitalization of earnings; permanently retained in the
business; no assets are distributed
• Shareholders have exactly the same proportionate
interest and company has the same total book value
• Book value per share is lower because more shares
• Results in an increase in the number of shares
outstanding and the share capital with an equal reduction
in retained earnings
• Amount of stated capital depends on the amount
declared
• If the dividend is large enough, there may be a decrease in
the market price of the share
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Accounting for Stock Dividends
PiP 15.8 Facts: A company has 1,000 common shares outstanding
and retained earnings of $50,000. A 10% stock dividend is
declared. The declared amount of the dividend is the fair value,
$130 per share. The shareholders had the option to take the
dividend in cash but chose not to.

The dividend is
measured at the fair
value of the shares on
the date of declaration:
1,000 × 10% × $130 as Otherwise, the value would be based on the
declared amount
required by GAAP when
there is a cash option.

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Effects of a Stock Dividend
Because
everyone
received the
same
percentage of
shares; the
proportionate
number of
shares held by
each
shareholder is
unchanged.

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Liquidating Dividends
• Dividends that are paid out of contributed surplus
• Excess of accumulated income considered a return of
shareholders’ investment (return of capital)
PiP 15.9 Facts: A company issued a dividend of $1.2 million to it
common shareholders. $900,000 was considered to be a return of
income, while the rest represented a return of capital.

Liquidating
Dividend

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Dividend Preferences—Scenario One
PiP 15.10 $50,000 to be distributed as cash dividends; outstanding
common shares have a book value of $400,000; 1,000 $6 preferred shares
outstanding (issued for $100,000).

1. If the preferred shares are non-cumulative and non-participating

Allocation: Preferred $6,000; Common $44,000

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Dividend Preferences—Scenario Two
PiP 15.10 $50,000 to be distributed as cash dividends; outstanding
common shares have a book value of $400,000; 1,000 $6 preferred shares
outstanding (issued for $100,000).

2. Preferred shares are cumulative and non-participating;

dividends on preferred shares not paid in previous 2 years

Allocation: Preferred $18,000; Common $32,000

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Dividend Preferences—Scenario Three
PiP 15.10 $50,000 to be distributed as cash dividends; outstanding
common shares have a book value of $400,000; 1,000 $6 preferred shares
outstanding (issued for $100,000).
3. Preferred shares are non-cumulative and fully participating

Allocation: Preferred $10,000; Common $40,000

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Dividend Preferences—Scenario Four
PiP 15.10 $50,000 to be distributed as cash dividends; outstanding
common shares have a book value of $400,000; 1,000 $6 preferred shares
outstanding (issued for $100,000).
4. Preferred shares are cumulative and fully participating; dividends on
preferred shares not paid in previous 2 years

Allocation: Preferred $19,600; Common $30,400

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Stock Splits versus Stock Dividends
• Higher the market price; harder for investors to buy in
• To reduce the market price of shares, use stock splits
o Results in an increase in the number of shares outstanding
with no change in the amounts of share capital or retained
earnings
o From an accounting standpoint, a memorandum note is
required to indicate the number of shares has increased
• If a stock dividend is large enough it has the same effect as a
stock split, and can be treated as a stock split (SEC)
• A large stock dividend is more than 20% to 25% of shares
o ASPE and IFRS are silent on this issue

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Components of Shareholders’ Equity
1. Share Capital Contributed (Paid-in) Capital:
2. Contributed Surplus Amount shareholders provide

3. Retained Earnings
Earned Capital: Amount created
4. Accumulated other by business profits
comprehensive income

IFRS: Detailed ASPE: Statement of

Presentation: statement of changes in retained
changes in earnings; contributed
shareholders’ equity capital changes in notes
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Transactions Affecting Shareholders’ Equity: Contributed
Surplus

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Transactions Affecting Shareholders’ Equity:
Retained Earnings

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Transactions Affecting Shareholders’
Equity: Accumulated Other
Comprehensive Income
• Cumulative change in equity due to revenues/expenses
and gains/losses from non-shareholder transactions
excluded from net income
• Represents earned income
• Could include income that has not been realized
• Included in Statement of Changes in Shareholders’ Equity
under IFRS
• Not applicable under ASPE

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Capital Disclosures
• Normal disclosures:
o Amount of authorized, issued and fully paid shares
o Rights, preferences, any restrictions
o Reconciliation between opening and closing balances
• Restrictions on retained earnings or dividends—sources,
provisions, and amounts
• Additional under IFRS
o Objectives, policies, processes for managing capital
o Summary quantitative date about what the company
manages as capital, and any changes

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Analytics—Return on Equity and
Payout Ratio
• Rate of return on common shareholders’ equity—shows
how many dollars of net income were earned for each
dollar invested by the owners

• Payout ratio—the ratio of cash dividends to net income

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Analytics—Price Earnings Ratio and
Book Value per Share
• Price earnings ratio—used in discussing the investment
potential of an enterprise

• Book value per share—amount that each share would

receive if the company were liquidated

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A Comparison of IFRS and ASPE
• In several cases, ASPE provides more guidance than IFRS
• Where no explicit guidance is given, the accounting for
IFRS may end up the same as ASPE using basic principles
• Refer to Illustration 15.8 in the text

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Looking Ahead
• Deliberations are continuing on the Financial Instruments
with Characteristics of Equity project
• Discussion on adding two additional disclosures (IFRS 7)
o The nature and priority of claims against an entity
o Terms and conditions about priority on liquidation for
particular financial instruments

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Copyright
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