FINANCING:FINANCING:

Part 3A: EquityPart 3A: Equity

CHAPTERSCHAPTERS

13-1613-16

CORPORATIONSCORPORATIONSKindsKinds

Profit or non-profit

Publicly-held, or privately held

Sole Proprietorship

Partnership Corporation

Service

Merchandise

Manufacturing

CORPORATIONSCORPORATIONSFrom Grade 11From Grade 11

A corporation is a personIt is a legal entity that is separate and

distinct from its ownersThe shareholders own the corporation;

the corporation owns the assets.

OwnThe Legal

Entity of the Corporation

The Legal Entity of the Corporation

Owns

Remits wealthThe Legal

Entity of the Corporation

The Legal Entity of the Corporation

Make profit

CORPORATIONSCORPORATIONSFrom Grade 11From Grade 11

Likewise, as separate legal entities, corporations and their owners are taxed

separately.

TA

X

TA

X

(Dividends)

CORPORATIONSCORPORATIONSCharacteristics – From Grade 11Characteristics – From Grade 11

Separate legal entity Have shares which represent ownership Common shares come with voting rights Limited liability of shareholders Transferable ownership rights Ability to acquire capital more easily Continuous life Management can be separate from owners Government regulations (lots) Possibility of double taxation

Advantages Disadvantages

• Corporate management - professional managers

• Separate legal existence

• Limited liability of shareholders

• Deferred or reduced income taxes

• Transferable ownership rights

• Ability to acquire capital

• Continuous life

• Corporation management - ownership separated from management

• Increased costs and complexity to adhere to government regulation

• Potential for additional income taxes

CORPORATIONSCORPORATIONSCharacteristics – From Grade 11Characteristics – From Grade 11

CORPORATIONSCORPORATIONSOrganization CostsOrganization Costs

Costs incurred in forming a corporation are called organization costs.

Organization costs are normally expensed in the year the organization cost is incurred.

CORPORATIONSCORPORATIONSShares – The BasicsShares – The Basics

To raise capital, a corporation sells shares

Several types, but always common (voting) shares

Authorized shares– Total number of shares allowed to be sold (as authorized by corporate

charter).

Issued shares– Total number of shares actually sold and outstanding.

CORPORATIONSCORPORATIONSShares – Stock Market PriceShares – Stock Market Price

Shares of publicly held companies are traded on stock exchanges

According to Capital Market Theory, just like bonds, share prices are determined by two factors:

1. The NPV of expected future cash flows from business operations (discounted to the present)

2. Supply and demand for the stock.

Shares Legal Capital per Share

CORPORATIONSCORPORATIONSShares - Par, No Par And Stated ValueShares - Par, No Par And Stated Value

Par value Par value

No par value

Entire proceeds

Stated value

Stated value

A Corporation must retain legal capital.Note: Legal capital has NO

relationship to market value once issued.

CORPORATIONSCORPORATIONSShares - Par, No Par And Stated ValueShares - Par, No Par And Stated Value

What goes into the Equity Accounts

Par value and Stated value – are assigned values given to issued shares.

Originally they were required to ensure shares would always have some value. Their significance is now next to meaningless

For No-par shares, legal capital equals the proceeds from issuing the stock to the public.

CORPORATIONSCORPORATIONS Shares – Par Value, Stated Value, and No-Par ValueShares – Par Value, Stated Value, and No-Par Value

CORPORATIONSCORPORATIONSStatement of Shareholder’s EquityStatement of Shareholder’s Equity

The shareholders’ equity section of a corporation’s balance sheet consists of:

1. Contributed capital (from proceeds from issue of shares)

– Share capital (par or stated value)

– Additional contributed capital (beyond par or stated value)

2. Retained earnings (profit retained in the business)

CORPORATIONSCORPORATIONSStatement of Shareholder’s EquityStatement of Shareholder’s Equity

Shareholder’s EquityContributed Capital

Common shares: 2,000 $1 stated value shares, (50,000 authorized).

Contributed capital in excess of stated value

Total Contributed Capital

Retained EarningsRetained Earnings, January 1st

Add: Net IncomeLess: Cash DividendsChange in Retained Earnings for the period.

Retained Earnings, December 31st

Total Shareholder’s Equity

2,000

18,000

$30,000

$30,000$150,000

(80,000)70,000

100,000

$130,000

Share Capital

Additional Contributed Capital

Note: when common shares have No-par value, the entire proceeds are legal capital, and are credited to

Common Shares. Observe...

Date Particulars Debit CreditJuly 31 Cash 20,000

Common Shares 20,000

Issued 2,000 no-par shares for $10 per share.

When common shares have par value or stated value, this value is credited to “Common Shares” as you see here.

Any proceeds beyond the stated value are credited to “Contributed Capital in Excess of Stated Value.”

Observe…

Date Particulars Debit Credit

Sept 30 Cash 20,000Common Shares (stated value only) 2,000Contributed Capital in Excess of Stated Value 18,000

Issued 2,000 shares with a stated value of $1 per share for $10 each.

Preferred Shares,$5 no par, cumulative (1,000 issued, 10,000 authorized). $10,000

Preferred shares have priority over common shares with regards to:

1. Dividends and 2. Any payments in the event of

liquidation All dividends must be paid to preferred

shareholders before common shareholders can receive anything (including past owed dividends)

They can often be redeemable/callable/or convertible

They usually don’t have voting rights

CORPORATIONSCORPORATIONSPreferred Shares - BasicsPreferred Shares - Basics

RETURN ON EQUITYRETURN ON EQUITYRETURN ON EQUITYRETURN ON EQUITY

Return on equity (or return on investment) is considered to be the most important measure of a firm’s profitability and efficiency.

Evaluates how many dollars were earned for each dollar invested by the owners.

=Net IncomeAverage

Shareholders Equity

Return on Equity

BOOK VALUE PER SHARE BOOK VALUE PER SHARE

Book value per share represents the equity a common shareholder has in the net assets of the corporation from owning one share.

The formula for calculating book value per share when a corporation has only one class of shares is:

=Total

Shareholders’ Equity

Number of Common

Shares

Book Value per Share

When a company has both preferred and common shares, the calculation of book value is more complex.

Steps required are:1. Calculate the preferred shareholders’ equity (the sum of

redemption price of preferred shares plus any cumulative dividends in arrears).

2. Determine the common shareholders’ equity (total shareholders’ equity less preferred shareholders’ equity).

3. Divide common shareholders’ equity by the number of common shares to determine book value per share.

CALCULATION OF BOOK VALUE CALCULATION OF BOOK VALUE WITH PREFERRED SHARESWITH PREFERRED SHARES

Do Problems:

BE14-1 and BE14-10

E14-7 (no memo required)

P14-4A (use T-accounts to post)

P14-5A (you’ll have to read the text learn how to calculate this ratio when you have preferred

shares)