Chapter 2 Lecture Notes 2020-2021 PDF

Features of Preference Shares Features of Preference Shares Cumulative A corporation may attach Participating whatever preferences or restrictions it desires, as Convertible...

Features of Preference Shares Features of Preference Shares Cumulative A corporation may attach Participating whatever preferences or restrictions it desires, as Convertible long as it does not violate its Callable country’s incorporation law. Redeemable The accounting for preference shares at issuance is similar to that for ordinary shares. LO 1 Copyright ©2020 John Wiley & Sons, Inc. 1 Journal Entry to Issue Preference Shares Illustration: Bishop plc issues 10,000 shares of £10 par value preference shares for £12 cash per share. Bishop records the issuance as follows: Cash 120,000 Share Capital — Preference 100,000 Share Premium — Preference 20,000 LO 1 Copyright ©2020 John Wiley & Sons, Inc. 2  Learning Objective 2 Explain the accounting and reporting for treasury shares LO 2 Copyright ©2020 John Wiley & Sons, Inc. 3 Reacquisition of Shares Companies purchase their outstanding shares to: 1. Provide tax-efficient distributions of excess cash to shareholders. 2. Increase earnings per share and return on equity. 3. Provide shares for employee compensation contracts or to meet potential merger needs. 4. Thwart takeover attempts or to reduce the number of shareholders. 5. Make a market in the shares. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 4 Purchase of Treasury Shares Two acceptable methods: Cost method (more widely used). Par (stated) value method. Treasury shares reduce equity. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 5 Equity with No Treasury Shares Illustration: Pacific Company issued 100,000 shares of $1 par value ordinary shares at a price of $10 per share. In addition, it has retained earnings of $300,000. Equity section before re-acquisition of shares ILLUSTRATION 15.5 LO 2 Copyright ©2020 John Wiley & Sons, Inc. 6 Journal Entry to Record Purchase of Treasury Shares Illustration: Pacific Company issued 100,000 shares of $1 par value ordinary shares at a price of $10 per share. In addition, it has retained earnings of $300,000. On January 20, 2020, Pacific acquires 10,000 of its shares at $11 per share. Pacific records the reacquisition as follows. Treasury Shares 110,000 Cash 110,000 LO 2 Copyright ©2020 John Wiley & Sons, Inc. 7 Equity with Treasury Shares Illustration: The equity section for Pacific after purchase of the treasury shares. ILLUSTRATION 15.6 LO 2 Copyright ©2020 John Wiley & Sons, Inc. 8 Sale of Treasury Shares Above Cost Below Cost Both increase total assets and equity. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 9 Sale of Treasury Shares Above Cost Pacific acquired 10,000 treasury shares at $11 per share. It now sells 1,000 shares at $15 per share on March 10. Pacific records the entry as follows. Cash (1,000 x $15) 15,000 Treasury Shares (1,000 x $11) 11,000 Share Premium — Treasury 4,000 LO 2 Copyright ©2020 John Wiley & Sons, Inc. 10 Sale of Treasury Shares Below Cost Pacific sells an additional 1,000 treasury shares on March 21 at $8 per share, it records the sale as follows. Cash (1,000 x $8) 8,000 Share Premium — Treasury 3,000 Treasury Shares (1,000 x $11) 11,000 LO 2 Copyright ©2020 John Wiley & Sons, Inc. 11 Sale of Treasury Shares Below Cost (continued) ILLUSTRATION 15.7 Assume that Pacific sells an additional 1,000 shares at $8 per share on April 10. After eliminating the credit balance in share Premium—Treasury, the corporation debits any additional excess of cost over selling price to Retained Earnings. Cash (1,000 x $8) 8,000 Share Premium — Treasury 1,000 Retained Earnings 2,000 Treasury Shares (1,000 x $11) 11,000 LO 2 Copyright ©2020 John Wiley & Sons, Inc. 12 Retiring Treasury Shares Decision results in cancellation of the treasury shares and a reduction in the number of shares of issued shares. Retired treasury shares have the status of authorized and unissued shares. LO 2 Copyright ©2020 John Wiley & Sons, Inc. 13  Learning Objective 3 Explain the accounting and reporting issues related to dividends. LO 3 Copyright ©2020 John Wiley & Sons, Inc. 14 Dividend Policy Few companies pay dividends in amounts equal to their legally available retained earnings. Why? 1. Maintain agreements with creditors. 2. Meet corporation requirements. 3. To finance growth or expansion. 4. To smooth out dividend payments. 5. To build up a cushion against possible losses. LO 3 Copyright ©2020 John Wiley & Sons, Inc. 15 Financial Condition and Dividend Distributions Before declaring a dividend, management must consider availability of funds to pay the dividend. Should not pay a dividend unless both the present and future financial position warrant the distribution. LO 3 Copyright ©2020 John Wiley & Sons, Inc. 16 Types of Dividends 1. Cash dividends. 2. Property dividends 3. Liquidating dividends. 4. Share dividends. All dividends, except for share dividends, reduce the total equity in the corporation. LO 3 Copyright ©2020 John Wiley & Sons, Inc. 17 Cash Dividends Board of directors vote on the declaration of cash dividends. A declared cash dividend is a liability. Companies do not declare or pay cash dividends on treasury shares. Three dates: a. Date of declaration b. Date of record c. Date of payment LO 3 Copyright ©2020 John Wiley & Sons, Inc. 18 Cash Dividends Journal Entries Illustration: Roadway Freight Corp. on June 10 declared a cash dividend of 50 cents a share on 1.8 million shares payable July 16 to all shareholders of record June 24. At date of declaration (June 10) Retained Earnings 900,000 Dividends Payable 900,000 At date of record (June 24) No entry At date of payment (July 16) Dividends Payable 900,000 Cash 900,000 ILLUSTRATION 15.10 LO 3 Copyright ©2020 John Wiley & Sons, Inc. 19 Property Dividends Dividends payable in assets other than cash. Restate at fair value the property it will distribute, recognizing any gain or loss. LO 3 Copyright ©2020 John Wiley & Sons, Inc. 20 Property Dividends Journal Entry on Declaration Date Illustration: Tsen, Ltd. transferred to shareholders some of its investments in securities with a carrying value of HK$1,250,000 by declaring a property dividend on December 28, 2021, to be distributed on January 30, 2022, to shareholders of record on January 15, 2022. At the date of declaration the securities have a fair value of HK$2,000,000. Tsen makes the following entries. At date of declaration (December 28, 2021) Equity Investments 750,000 Unrealized Holding Gain or Loss — Income 750,000 Retained Earnings 2,000,000 Property Dividends Payable 2,000,000 ILLUSTRATION 15.11 LO 3 Copyright ©2020 John Wiley & Sons, Inc. 21 Property Dividends Journal Entry on Date of Distribution At date of distribution (January 30, 2022) Property Dividends Payable 2,000,000 Equity Investments 2,000,000 ILLUSTRATION 15.11 LO 3 Copyright ©2020 John Wiley & Sons, Inc. 22 Liquidating Dividends Any dividend not based on earnings reduces amounts paid-in by shareholders. LO 3 Copyright ©2020 John Wiley & Sons, Inc. 23 Liquidating Dividends Journal Entry on Date of Declaration Illustration: McChesney Mines Inc. issued a “dividend” to its ordinary shareholders of £1,200,000. The cash dividend announcement noted that shareholders should consider £900,000 as income and the remainder a return of capital. McChesney Mines records the dividend as follows. At date of declaration Retained Earnings 900,000 Share Premium — Ordinary 300,000 Dividends Payable 1,200,000 ILLUSTRATION 15.12 LO 3 Copyright ©2020 John Wiley & Sons, Inc. 24 Liquidating Dividends Journal Entry on Date of Payment At date of payment Dividends Payable 1,200,000 Cash 1,200,000 ILLUSTRATION 15.12 LO 3 Copyright ©2020 John Wiley & Sons, Inc. 25 Share Dividends Issuance by a corporation of its own shares to shareholders on a pro rata basis, without receiving any consideration. Par value, not the fair value, is used to record the share dividend. Share dividend does not affect any asset or liability. Journal entry reflects a reclassification of equity. Ordinary share dividend distributable reported in the equity section as an addition to share capital—ordinary. LO 3 Copyright ©2020 John Wiley & Sons, Inc. 26 Share Dividends Journal Entry on Date of Declaration Illustration: Vine plc has outstanding 100,000 shares of £1 par value ordinary shares and retained earnings of £50,000. If Vine declares a 10 percent share dividend, it issues 10,000 additional shares to current shareholders. If the fair value of the shares at the time of the share dividend is £8 per share, the entry is: At date of declaration Retained Earnings (Share Dividend Declared) 10,000 Ordinary Share Dividend Distributable 10,000 LO 3 Copyright ©2020 John Wiley & Sons, Inc. 27 Share Dividends Journal Entry on Date of Distribution At date of distribution Ordinary Share Dividend Distributable 10,000 Share Capital — Ordinary 10,000 LO 3 Copyright ©2020 John Wiley & Sons, Inc. 28 Effects of Share Dividends ILLUSTRATION 15.13 LO 3 Copyright ©2020 John Wiley & Sons, Inc. 29 Share Splits To reduce the market value of shares. No entry recorded for a share split. Decrease par value and increased number of shares. ILLUSTRATION 15.14 LO 3 Copyright ©2020 John Wiley & Sons, Inc. 30 Share Split and Share Dividend Differentiated Share Split and Share Dividend Differentiated A share split differs from a share dividend. How? A share split increases the number of shares outstanding and decreases the par or stated value per share. A share dividend, o increases the number of shares outstanding. o does not decrease the par value. o increases the total par value of outstanding shares. LO 3 Copyright ©2020 John Wiley & Sons, Inc. 31