148 Copyright 2014 Pearson Canada Inc.

148 Copyright © 2014 Pearson Canada Inc.Chapter 13

Corporations: Share Capital

and the Balance Sheet Questions

1. Corporation characteristics:

• a separate legal entity, formed under federal or provincial law • continuous life and transferability of ownership • no mutual agency • limited liability of shareholders • separation of ownership and management • corporate earnings subject to a degree of double taxation • government regulation • corporations may incur costs unique to corporations.

• The corporation itself pays income tax, and the shareholder pays personal tax on

after-tax dividends received from the corporation. However, a portion of the corporate tax is allowed as a dividend tax credit to the shareholder to eliminate some of the double taxation.

• The incorporators pay the fees and file the required documents with the

incorporating jurisdiction, and approval of articles of incorporation is granted by the federal or a provincial government. The articles of incorporation include authorization for the corporation to issue a certain number of shares.The incorporators agree to a set of bylaws for governing the corporation. The corporation then issues its shares and receives assets. The shareholders elect the board of directors, which appoints the officers. At this point, the corporation begins operations.

• Characteristic Corporation Partnership

Legal Entity – a business entity – does not require formed under federal federal or provincial or provincial law approval to do business – corporation a distinct – partnership not entity; assets and distinct from partners liabilities belong to who hold all assets corporation and liabilities Continuous Life – sale or transfer of – partnerships and Transferability shares does not affect terminate when of Ownership the continuity of the ownership changes corporation

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Copyright © 2014 Pearson Canada Inc. 149 Characteristic Corporation Partnership Mutual Agency – officers commit the – a partner can bind corporation to contracts partnership by but not shareholders signing contract Liability – shareholders have no – partners are personally personal obligation for liable for all debts of corporate liabilities; the partnership however, directors may Ownership/ – corporations are – partners manage Management owned by shareholders the partnership who elect a board of directors – the board of directors appoints officers to manage the business Taxation – corporate earnings are – partners are taxed subject to two different on their share of

types of taxation: partnership income

corporate income is taxed and after-tax dividends are taxable to the shareholder Additional costs – corporations incur costs – partnerships do not incur unique to corporations, these costs such as the cost of directors’ insurance

5. A common shareholder has the right to: (a) vote on matters that come before

the shareholders, (b) receive a proportionate part of any dividends declared on that class of shares, (c) receive a proportionate share of corporate assets if the corporation liquidates, (d) sell the shares and (e) a pre-emptive right, the right to maintain one’s proportionate ownership in the corporation. Preferred shares are automatically voting, unless stated otherwise; however, they are typically nonvoting. These rights may be withheld by the corporation only by agreement with the shareholders.

• Issuance of shares increases the assets of the corporation, which receives

assets in exchange for shares issued. Authorization merely gives the corporation permission to issue shares.

• Issuance of 1,400 shares of $4.50 preferred shares for $110 would increase

the contributed capital by $154,000 (1,400 × $110). The transaction would not increase retained earnings because a company does not earn a profit by selling its shares to its own shareholders. Bala Ltd.’s annual cash dividend payments would increase by $6,300 (1,400 × $4.50).

• Cash 3,475

Common shares [(150 × $9) + (250 × $8.50)] 3,475

• Issuance of 1,500 common shares for land and a building worth $200,000

increases contributed capital by $200,000.

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10. Intangible assets: Organization Cost

Current liabilities: Dividends Payable

Shareholders’ equity: Preferred Shares, Common Shares, Retained Earnings.

• Organization Cost is an intangible asset account. It is debited for its cost

when acquired, and the cost is usually amortized as expense over a short period of time.

• Three important dates for dividends are: (a) Declaration date: the board of

directors announces the dividend, (b) Date of record: the corporation identifies the people who own the shares on this date so that they can receive the dividend.

(c) Payment date: the corporation pays the dividend.

13. (a) Cumulative preferred: $13,125 (2,500 × $1.75 × 3 years)

Common: $21,875 ($35,000 – $13,125)

(b) Noncumulative preferred: $4,375 (2,500 × $1.75)

Common: $30,625 ($35,000 – $4,375)

• A preferred shareholder would rather own cumulative preferred shares

because any preferred dividends passed by the corporation must be paid before paying dividends to the common shareholders. The corporation would rather issue noncumulative preferred shares in order to avoid having to pay dividends in arrears to preferred shareholders.

• Cumulative preferred dividends in arrears are reported in the notes to the

financial statements. Dividends become a liability only after the board of directors declares the dividends.

• The market value of a share is the price at which a person could buy or sell a

single share. The book value of a share is the total amount of shareholders’ equity of a certain type in the company’s books divided by the number of shares issued. Market value is far more important to investors than book value.

• In a company with both preferred and common shares outstanding, the

preferred shareholders have the first claim to shareholders’ equity. The book value of preferred shares is their liquidation value plus any cumulative preferred dividends in arrears if the preferred shares are cumulative. The remaining equity divided by the number of common shares gives the book value for each common share.

• A healthy company’s return on shareholders’ equity should exceed its return

on total assets because of the interest expense component of return on assets.Shareholders demand a higher rate of return than creditors. If return on total assets is higher than return on shareholders’ equity, the company may be over leveraged.

Copyright © 2014 Pearson Canada Inc. 151 Starters (5 min.) S 13-1

• The chairperson of the board of directors is usually the most powerful person

in a corporation.

• The shareholders hold ultimate power in a corporation.
• The president or Chief Executive Officer (CEO) is in charge of day-to-day

operations.

• The vice-president of accounting and finance is in charge of accounting.

(5 min.) S 13-2

DIFFERENCE:

A proprietorship’ s balance sheet reports a single capital account, such as Joe Hopper, Capital. A corporation balance sheet reports shareholders’ equity by

source. There are two sources: contributed capital and retained earnings.

SIMILARITY:

A proprietorship’ s balance sheet and a corporation’s balance sheet both report assets and liabilities in the same way.