Chapter 11 | Corporations: Organization, Share Transactions, and Equity

Learning Objectives:

1) Discuss the major characteristics of a corporation.

2) Explain the accounting for ordinary, preference, and treasury shares.
3) Explain how to account for cash dividends, share dividends, and share
splits.
4) Discuss how equity is reported and analysed.
Corporation and its Classification
Separate Entity Principle – Corporate is a legal entity which is distinctly separate from its
owners/ shareholders
Types | Classification
1) By Purpose
a) Not-for-Profit – section 42 companies
and includes NGOs, Trusts, Charities
etc.
b) For Profit – includes all commercial
businesses with the aim to earn profit
2) By Ownership
a) Publicly held – large number of shareholders
(general public); includes national and multi-
national big businesses
- Public companies may be listed (on stock
exchange)
b) Privately held – one or few limited individual
ownership
Prepared by Saira Rizwan for LUMS undergrad course ACCT-100
Characteristics of a Corporation
Characteristics that distinguish corporations from proprietorships and partnerships.

1) Separate Legal Existence | Corporate will have its unique name different from its owners
2) Limited Liability of Shareholders | limited to their investment in the business

Advantages
3) Transferable Ownership Rights | Shareholders may sell their shares
4) Ability to Acquire Capital | Corporate can obtain capital through issuance of shares
5) Continuous Life | Continuance as a going concern is not affected by the withdrawal,
death, or incapacity of a shareholder, employee, or officer.
6) Corporate Management | Separation of ownership and management prevents owners

Disadvantages
from having an active role in managing the company.
7) Government Regulations |Regulations are designed to protect the (minority) owners of
the Corporation.
8) Additional Taxes | Corporations pay income taxes as a separate legal entity and in
addition, shareholders pay taxes on cash dividends.

Prepared by Saira Rizwan for LUMS undergrad course ACCT-100

Corporation | Organogram OR Organizational Structure

Prepared by Saira Rizwan for LUMS undergrad course ACCT-100

 Prepared by Saira Rizwan for LUMS undergrad course ACCT-100

Corporation and Shareholders’ Rights

• Corporates are formed /enacted under the Companies Act issued by Securities & Exchange
Commission of the country.

• Corporates issue shares in the name of shareholders and the shares have face value (may be
traded at different price on stock exchange) and stamp of the company.
Shareholders have the right to
1) Vote in election of board of directors and on actions that require shareholder approval.
2) Share the corporate earnings through receipt of dividends
3) Keep the same percentage ownership when new shares are issued (preemptive right*).
4) Share in assets upon liquidation in proportion to their holdings – called a residual claim.

*The right of first offer (ROFO) If a corporation intends to increase its capital; first it will offer shares to
existing shareholders; thus protecting their shareholding from dilution.

If an existing shareholder intends to sell his shares; first right to refuse or

**The right of first refusal (ROFR) accept those shares lies with existing shareholders; if they refuse then it is
offered to public / new shareholder.
Share Issue Considerations
▪ Memorandum of Association (MOA) and Article of Association (AOA) are two legal documents drawn up at the
time of formation of a Corporate.

▪ MOA mainly outlines the nature of business, key shareholders, registered office, authorized capital while AOA
tells about how the company will operate, issued capital, responsibilities of directors and so on.

▪ Number of authorized shares is reported in the equity section of the company | No formal accounting entry

Issuance of Shares: Corporation can issue ordinary shares directly to investors or indirectly through
an investment banking firm / Financial Consulting companies.

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Factors in setting price for a new issue of shares:
✓ Company’s anticipated future earnings.
✓ Expected dividend rate per share
✓ Current financial position.
✓ Current state of the economy.
✓ Current state of the capital market.

Market Price of Shares: www.psx.com.pk

▪ Shares of publicly held companies is traded on SE.

▪ Interaction between buyers and sellers determines the prices per share.
▪ Prices tend to follow the trend of a company’s earnings and dividends.
▪ Factors beyond a company’s control may cause day-to-day fluctuations in market prices.

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 Accounting for Ordinary Shares Issue
Mellow Industries Ltd. issues 1,000 ordinary shares of $10 par value for (a) $10 per share, (b) $12 per
share. The journal entry in the books of Mellow Industries would be:

a) Cash [1,000* $10] 10,000

Share Capital – Ordinary 10,000
[1,000* $10]

b) Cash [1,000* $12] 12,000

Share Capital - Ordinary 10,000
[1,000* $10]
Share Premium 2,000
[1,000* ($12-10)]

Prepared by Saira Rizwan for LUMS undergrad course ACCT-100

Accounting for Ordinary Shares Issue

Assume that H&H legal advisors helped Mellow

Legal Expense 4,000
Industries to incorporate. They billed the company Share Capital – Ordinary 4,000
$4,000 for their services. They agree and accepted
400 shares of $10 par value shares in payment of
their bill. Record the transaction for Mellow Ind.
Share Premium =
Market value > Face value of share
Assume that shares (face value of $10/ share) of
Mellow Industries are traded on local bourse at Land [7,200* $12] 86,400
Share Capital - Ordinary 72,000
market value of $12. The company issues 7,200 [7,200* $10]
shares to acquire land recently advertised for sale Share Premium 14,400
[7,200* ($12-10)]
at $86,400. Record the transaction.

Prepared by Saira Rizwan for LUMS undergrad course ACCT-100

 Accounting for Treasury Shares
Treasury shares are a corporation’s own shares that it has reacquired from shareholders but not retired.
▪ Debit Treasury Shares for the price paid to reacquire the shares (cost method).

▪ Treasury Shares is a contra equity account (not an asset), so it reduces equity.

Corporations purchase their outstanding shares to: Mellow Industries

1) Increase earnings per share.

2) Enhance the share’s market value.
3) Reissue the shares to employees under bonus
and share compensation plans.
4) Have additional shares available for acquiring
stake in other companies through stock
transactions.
# of shares issued (100,000), outstanding (96,000), and
5) Buying back to eliminate hostile shareholders.
the # of shares held as treasury (4,000) are disclosed.
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 Disposal of Treasury Shares | Above OR Below Cost
▪ The disposal of Treasury shares results in both increase in asset and equity.
▪ A Company does not realize a gain or suffer a loss from share transactions with its own shareholders.
Above Cost [$325k/5,000 =$65]
Vision Ltd. purchases 5,000 shares of its $50 par value ordinary shares for $325,000 cash on July 1. It
will hold the shares in treasury until resold. On Nov. 1, the entity sells 1,500 treasury shares for cash at
$80 / share. Journalize the transaction.
Illustration Continues… Below Cost
Jul. 1
Treasury Shares 325,000 [$325k/5,000 =$65] On Dec. 25, Vision Ltd. sells remaining 3,500
Cash 325,000 treasury shares for cash at $50 per share.
Nov. 1
Cash 175,000
Cash 120,000 Limited to
Share Premium 22,500 bal. on hand
Treasury Shares [1,500*65] 97,500
Retained Earnings 30,000
Share Premium—Treasury 22,500
Treasury Shares 227,500
[3,500 *$65]
Prepared by Saira Rizwan for LUMS undergrad course ACCT-100