Organization and

Operation of
Corporations

CHAPTER

12

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 Characteristics of Corporations
• Separate legal entity
• Limited liability of shareholders
• Ownership rights are transferable
• Continuous life
• Shareholders are not corporate agents
• Ease of capital accumulation
• Government regulation
• Corporate taxation

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 Incorporation
• Corporation may be created under provincial or
federal laws.
• Charter, articles of incorporation, letters patent,
or memorandum of association is completed
and signed by the shareholders.
• Investors purchase shares and elect a board of
directors.

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 Organization Costs
• Costs include legal fees, promoters’ fees and
amounts paid to obtain a charter.
• Organization costs are expensed as incurred.

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Corporate Organization Structure

Shareholders

Board of directors

Chief executive officer (CEO)

and other executive officers

Employees of the corporation

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 Rights of Shareholders
According to the Canada Business
Corporations Act, shareholders have the
right to:
• Vote.
• Receive dividends that have been
declared.
• Receive property of the corporation after
its closure.

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QS 12-1: Characteristics of corporations:

Of the following statements, which are true for the corporation form of business?

a. Capital often is more easily accumulated than with other forms of organization.

b. It has a limited life.

c. Owners have unlimited liability for corporate debts.

d. It is a separate legal entity.

e. Ownership rights cannot be easily transferred.

SOLUTION: Quick Study 12-1:

a and d
 Corporate Financial Statements

• Income Statement
• Statement of Changes in Equity
• Balance Sheet

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 Corporation Single Proprietorship
Dell's Servicing
Income Statement
ABC Corporation For Year Ended December 31, 2017
Income Statement
For Year Ended December 31,2017
Revenues $116
Revenues $116 Operating expenses 40
Operating expenses 40
Profit from operations $76
Profit from operations $76
Other revenues and expenses Other revenues and expenses
Gain on sale of capital assets $7 Gain on sale of capital assets $7
Interest revenue 3
Loss on sale of capital assets (12)
Interest revenue 3
Interest expense (14) (16) Loss on sale of capital assets (12)
Profit before tax $60 Interest expense (14) (16)
Income tax expense 12
Profit $60
Profit $48

The statements are identical

except for the $12 of income tax
expense.
© 2016 McGraw-Hill Ryerson Limited. 10
 ABC Corporation
Statement of Changes in Equity
For Year Ended December 31, 2017
Share Retained Total Equity
Capital Earnings
Balance, Jan. 1 $0 $0 $0
Issuance of shares 500 500
Profit(loss) 48 48
Dividends (40) (40)
Balance, Dec. 31 $500 $8 $508

Shareholder (owner) investments are recorded in

the share capital account.

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 ABC Corporation
Statement of Changes in Equity
For Year Ended December 31, 2017
Share Retained Total Equity
Capital Earnings
Balance, Jan. 1 $0 $0 $0
Issuance of shares 500 500
Profit(loss) 48 48
Dividends (40) (40)
Balance, Dec. 31 $500 $8 $508

Retained earnings represents the income (profit)

to date that has been kept (retained) by the
corporation for the purpose of reinvestment.
© 2016 McGraw-Hill Ryerson Limited. 12
 ABC Corporation
Statement of Changes in Equity
For Year Ended December 31, 2017
Share Retained Total
Capital Earnings Equity
Balance, Jan. 1 $0 $0 $0
Issuance of shares 500 500
Profit (loss) 48 48
Dividends (40) (40)
Balance, Dec. 31 $500 $8 $508

Dell’s Servicing
Statement of Changes in Equity
For Year Ended December 31, 2017
I. Dell, Capital, January 1 $0
Add: Owner Investment $500
Profit 60
Total $560
Less: Withdrawals 40
I. Dell, Capital, December 31 $520

© 2016 McGraw-Hill Ryerson Limited. 13

 ABC Corporation
Partial Balance Sheet
December 31, 2017
Equity
Share Capital $500
Retained Earnings 8
Total Equity $508

Dell’s Servicing
Partial Balance Sheet
December 31, 2017
Equity
I. Dell, Capital $520

The balance sheets for corporations and single

proprietorships are identical except for the equity
section.
© 2016 McGraw-Hill Ryerson Limited. 14
 ABC Corporation
Partial Balance Sheet
December 31, 2017
Equity
Share Capital $500
Retained Earnings 8
Total Equity $508

Dell’s Servicing
Partial Balance Sheet
December 31, 2017
Equity
I. Dell, Capital $520

The equity sections for both organizations

include the same transactions in total: profits
(losses), distributions of profit, and owner
investments.
QS 12-3: Components of the equity section of a corporate balance sheet:

From the following list of selected accounts for Giant Inc., identify the equity accounts.
Use “CC” for contributed capital, “RE” for retained earnings, and “X” if not an equity
account.
SOLUTION: Quick Study 12-3:

 
X Cash CC Preferred shares
 
CC Common shares RE Retained earnings
 
X Common dividend payable X Preferred dividend payable
 
RE Deficit CC Preferred shares,
    $5 non-cumulative
QS 12-5: Retained earnings:

Benson Inc. had a credit balance in Retained Earnings on December 31, 2017, of
$48,000. During 2018, Benson recorded profit of $146,000 and declared and paid
dividends of $47,000. During 2019, the company recorded a loss of $15,000. No
dividends were declared or paid in 2019. Calculate the balance in Retained
Earnings at December 31, 2019.
$48,000 + $146,000 – $47,000 – $15,000 = $132,000

OR

Retained Earnings
48,000 Bal. Dec. 31/17

146,000 Profit, 2018

Dividends, 2018 47,000
Loss, 2019 15,000
132,000 Bal. Dec. 31/19
SOLUTION: Quick Study 12-5:

$48,000 + $146,000 – $47,000 – $15,000 = $132,000

OR

Retained Earnings
48,000 Bal. Dec. 31/17

146,000 Profit, 2018

Dividends, 2018 47,000
Loss, 2019 15,000
132,000 Bal. Dec. 31/19
QS 12-6: Analyzing retained earnings:

The Retained Earnings account for Callaho Inc. is shown below:

1. Calculate X.
2. What does X represent?
3. What caused the debit of $50,000?
SOLUTION: Quick Study 12-6:

1. $300,000 – $120,000 + $50,000 = $230,000

2. Profit
3. Dividends
QS 12-7: Preparing a statement of changes in equity:

Fisher Inc. began operations on January 1, 2017. During its first year,
$750,000 of common shares were issued and a net loss of $28,000 was
realized. In 2018, Fisher's second year of operations, an additional
$125,000 of common shares were issued, profit of $148,000 was earned,
and dividends of $40,000 were declared and paid. Prepare a statement of
changes in equity for the year ended December 31, 2018.
SOLUTION: Quick Study 12-7:

Fisher Inc.
Statement of Changes in Equity
For Year Ended December 31, 2018

Common Shares Retained Earnings Total Equity

Balance, January 1 $ 750,000 $(28,000) $ 722,000

Issuance of common shares 125,000   125,000

Profit   148,000 148,000
Dividends   (40,000) (40,000)
Balance, December 31 $ 875,000 $ 80,000 $ 955,000
 Issuing Shares
• Companies obtain capital, or money, by
issuing shares.
• This is referred to as equity financing.
• Shares may be sold directly to investors or
may be sold through a brokerage house.
• If a company only has one class of shares, they
are known as common shares.
• The CBCA requires all shares to be no par
value.
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 Issuing Share Capital
Example: On June 5, 2017 Dillon Snowboards
Ltd. issued 30,000 common shares for
$300,000 cash.
The entry to record this would be:
Cash 300,000
Common Shares 300,000

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 Equity
Example: June 30, 2017 Equity of Dillon Snowboards Ltd.
after the first year of operating. Assume profit of $65,000
and no dividend payments.

Equity

Common Shares, unlimited shares

authorized, 30,000 shares issued and
outstanding $300,000
Retained earnings 65,000
Total equity $365,000

© 2016 McGraw-Hill Ryerson Limited. 26

 Equity
Identifies how many shares the corporation is
allowed to sell.

Equity

Common Shares, unlimited shares

authorized, 30,000 shares issued and
outstanding $300,000
Retained earnings 65,000
Total equity $365,000

© 2016 McGraw-Hill Ryerson Limited. 27

 Equity
Identifies how many shares have been sold or
given out.

Equity

Common Shares, unlimited shares

authorized, 30,000 shares issued and
outstanding $300,000
Retained earnings 65,000
Total equity $365,000

© 2016 McGraw-Hill Ryerson Limited. 28

 Equity

Defines how many shares are held by shareholders.

Equity

Common Shares, unlimited shares

authorized, 30,000 shares issued and
outstanding $300,000
Retained earnings 65,000
Total equity $365,000

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 Equity
Discloses dollars invested by shareholders in exchange
for shares.

Equity

Common Shares, unlimited shares

authorized, 30,000 shares issued and
outstanding $300,000
Retained earnings 65,000
Total equity $365,000

© 2016 McGraw-Hill Ryerson Limited. 30

 Equity

This reflects accumulated profits/losses less dividends.

Equity

Common Shares, unlimited shares

authorized, 30,000 shares issued and
outstanding $300,000
Retained earnings 65,000
Total equity $365,000

© 2016 McGraw-Hill Ryerson Limited. 31

Issuing Commons Shares for Non-
Cash Assets
Example: On July 17, 2017 Dillon Snowboards Ltd. issued 4,000
common shares for land valued at $105,000.
The entry to record this would be:

Land 105,000
Common Shares 105,000

© 2016 McGraw-Hill Education 12-32

 Equity
Example: July 31, 2017, Equity of Dillon Snowboards Ltd.
after the first year of operating. Assume profit earned in
July was $82,000 and no dividend payments.

EXHIBIT 12.7

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 Mini-Quiz
The category of equity created by a
corporation's profitable activities is called:
A. Contributed capital.
B. Intangibles.  
C. Retained earnings.  
D. Paid-in capital.  
E. P & L.

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 Mini-Quiz
The category of shareholders' equity created
by a corporation's profitable activities is
called:
A. Contributed capital.
B. Intangibles.  
C. Retained earnings.  
D. Paid-in capital.  
E. P & L.

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 Preferred Shares
• Shares that give their owners a priority status
over common shareholders including:
• Receiving dividends, and
• Distribution of assets on liquidation.
• Do not usually have the right to vote.
• Are listed before common shares in the equity
section.

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 Issuing Preferred Shares for Cash
Example: August 3, 2017 Dillon Snowboards
Ltd. issued 5,000 preferred shares with a
dividend preference of $3 per share for a total
of $125,000 cash.
The entry to record this would be:
Cash 125,000
Preferred Shares 125,000

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 Equity
After Issue of Preferred Shares
Equity
Contributed Capital:
Preferred shares, $3, unlimited shares authorized,
5,000 shares issued and outstanding
$125,000
Common Shares, unlimited shares authorized,
34,000 shares issued and outstanding
$405,000
Represents the dividend preference. Preferred
Total contributed are
shareholders capital
entitled to dividends at the rate of$530,000
$3
per preferred
Retained earningsshare when declared. 303,000
Total equity $833,000

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 Preferred Shares
Reasons for issuing preferred shares include:
• No sacrifice of control,
• Potential to increase return to common
shareholders,
• Appeal to potential investors, and
• Market price of common shares may be too
low.

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Exercise 12-2: Issuing shares:

Prepare journal entries for each of the following selected transactions that occurred
during Tio Networks Corporation's first year of operations:
SOLUTION: Exercise 12-2:

2017
2014
Jan. 15 Organization Expenses (or other various expenses) ........ 31,500
Common Shares.......................................................... 31,500
Issued common shares to promoters.

Feb. 21 Cash ................................................................................... 210,000

Common Shares.......................................................... 210,000
Issued common shares for cash;
15,000 shares x $14/share = $210,000.

Mar. 9 Cash ................................................................................... 110,600

Preferred Shares ......................................................... 110,600
Issued preferred shares for cash.

Aug. 15 Land ................................................................................... 315,000

Building .............................................................................. 420,000
Equipment.......................................................................... 112,000
Common Shares.......................................................... 847,000
Issued common shares in exchange for land,
building, and equipment.
Exercise 12-3: Share transactions, equity:

Fierra Sceptre Inc. was authorized to issue 50,000 $1.50 preferred shares and
300,000 common shares. During 2017, its first year of operations, the following
selected transactions occurred:

Required:

a. Journalize the above transactions.

b. Prepare the equity section of Fierra Sceptre Inc.'s balance sheet at December 31, 2017.
c. The preferred shares are described as “$1.50 preferred shares.” Explain what the $1.50
means.
SOLUTION: Exercise 12-3:

a)
2014
2017
Jan. 1 Cash ...................................................................... 60,000
Preferred Shares ............................................. 60,000
Issued preferred shares; 5,000 × $12/share = 60,000.

Feb. 5 Cash ...................................................................... 126,000

Common Shares ............................................. 126,000
Issued common shares.

Mar. 20 Organization Expenses (or other various expenses) 28,800

Common Shares ............................................. 28,800
Issued shares to organizers for their work.

May 15 Cash ...................................................................... 350,400

Preferred Shares ............................................. 158,400
Common Shares ............................................. 192,000
Issued preferred and common shares; 12,000 × $13.20/share =
$158,400; 20,000 × $9.60/share = $192,000.

Dec. 31 Retained Earnings ................................................. 329,000

Income Summary ............................................ 329,000
Closed the net loss to Retained Earnings.
CONT’D SOLUTION: Exercise 12-3:
b) FIERRA SCEPTRE INC.
Equity Section of the Balance Sheet
December 31, 2014
December 31, 2017
Contributed Capital:
Preferred Shares, $1.50; 50,000 shares authorized;
17,0001 shares issued and outstanding ............... $218,4001
Common Shares
300,000 shares authorized;
38,0002 shares issued and outstanding ............... 346,8002
Total contributed capital ........................................ $565,200
Deficit ........................................................................ (329,000)
Total equity ................................................................ $236,200

Calculations:
1. Preferred Shares: Shares Dollars
Jan. 1 Issued 5,000 shares (5,000 x $12.00) ............................. 5,000 $ 60,000
May 15 12,000 shares issued (12,000 x $13.20) ......................... 12,000 158,400
Totals ...........................................................................
17,000 $ 218,400

2. Common Shares:
Feb. 5 Issued 15,000 shares .................................................... 15,000 $126,000
Mar. 20 Issued 3,000 shares ......................................................3,000 28,800
May 15 20,000 shares issued (20,000 x $9.60) ........................... 20,000 192,000
Totals ...........................................................................
38,000 $346,800

c) The $1.50 is the dividend entitlement per preferred share or how much each
preferred share is supposed to get in dividends each year.
 Dividends
• Are a distribution of earnings to shareholders
• Reduce retained earnings
• Are decided by the board of directors
• May be in cash or shares

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 Dividends
Important dates:
1. Date of declaration
The date the directors vote to pay a dividend.
This creates a legal liability for the corporation.

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 Dividends
Important dates:
1. Date of declaration
2. Date of record
3. future
The Date ofdate
payment
specified by the directors for
identifying those shareholders listed in the
corporation’s records to receive dividends.

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 Dividends
Important dates:
1. Date of declaration
2. Date of record
3. Date of payment
The date the shareholders receive payment.

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 Cash Dividends
Example: On November 9, the board of directors of a
company with 5,000 common shares outstanding
declared a $1 per share dividend payable December 1 to
the shareholders of record on November 22.
On November 9, the date of declaration, the entry
would be either:

Cash Dividends 5,000

Common Dividends Payable 5,000

or

Retained Earnings 5,000

Common Dividends Payable 5,000

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 Cash Dividends
No entry is required on November 22, the date of
record.

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 Cash Dividends
On December 1, the date of payment, the entry would
be:

Common Dividends Payable 5,000

Cash 5,000

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 Cash Dividends
On December 31, the corporation’s year end, the
closing entry would be:
Retained Earnings 5,000
Cash Dividends 5,000

No closing entry would be necessary if the Retained

Earnings account was debited on the date of
declaration.

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 Deficits and Cash Dividends
• A corporation with a debit balance in Retained
Earnings is said to have a deficit.
• Deficits reduce total equity.
• Corporations are not allowed to pay cash dividends
when there is a deficit.

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 Mini-Quiz
The declaration and payment of a dividend will
reduce the following two accounts:
A) Common shares and cash 
B) Cash and retained earnings 
C) Equity and retained earnings 
D) Retained earnings and accounts payable 
E) Equity and cash

© 2016 McGraw-Hill Ryerson Limited.

 Mini-Quiz
The declaration and payment of a dividend will
reduce the following two accounts:
A) Common shares and cash 
B) Cash and retained earnings 
C) Equity and retained earnings 
D) Retained earnings and accounts payable 
E) Equity and cash

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QS 12-11: Accounting for cash dividends:

Prepare journal entries to record the following transactions for Desmond Corporation:

Apr. 15 Declared a $48,000 cash dividend payable to common shareholders.

June 30 Paid the dividend declared on April 15.

Dec. 31 Closed the Cash Dividends account.
SOLUTION: Quick Study 12-11:
Apr. 15 Cash Dividends ..................................................... 48,000
Common Dividend Payable .......................... 48,000
Declared a cash dividend on common
shares.

June 30 Common Dividend Payable .................................. 48,000

Cash ............................................................. 48,000
Paid the cash dividend to common
shareholders.

Dec. 31 Retained Earnings ................................................ 48,000

Cash Dividends ............................................. 48,000
To close the Cash Dividends account.

OR

Apr. 15 Retained Earnings ........................................... 48,000

Common Dividend Payable ..................... 48,000
Declared a cash dividend on common
shares.

June 30 Common Dividend Payable ............................. 48,000

Cash ........................................................ 48,000
Paid the cash dividend to common
shareholders.

Dec. 31 No entry required.

Exercise 12-4: Cash dividend:

On March 1, the board of directors declared a cash dividend of $0.75 per

common share to shareholders of record on March 10, payable March 31.
There were 125,000 shares issued and outstanding on March 1 and no
additional shares had been issued during the month. Record the entries for
March 1, 10, and 31.
SOLUTION: Exercise 12-4:

March 1 Cash Dividends or Retained Earnings .......................... 93,750

Common Dividends Payable................................ 93,750
To record declaration of cash dividend on common
shares of $0.75 per share.

10 No entry.

31 Common Dividends Payable ......................................... 93,750

Cash ................................................................... 93,750
Paid the dividends declared on March 1.
 Preferred Shares
• Common shares cannot receive dividends
unless preferred share dividends are paid first.
• Preferred dividends are not guaranteed.
• The board of directors must declare a dividend
before shareholders are entitled to a dividend.
• Preferred shares may be either cumulative or
non-cumulative.

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 Preferred Shares
Cumulative
• Undeclared dividends accumulate until they are
paid.
• Common shareholders cannot receive dividends
until all cumulative dividends are paid.
Non-Cumulative
• Have no right to prior periods’ unpaid dividends if
they were not declared.

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 Financial Disclosure of Dividends

• A liability for a dividend does not exist until

the directors declare a dividend.
• Dividends in arrears on cumulative preferred
shares must be disclosed in the corporation’s
financial statements.

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 Preferred Shares
Non-participating
• Have dividends limited to a maximum amount
each year.
Participating
• Have a feature in which preferred shareholders
share with common shareholders in any
dividends paid in excess of the dollar amount
stated on the preferred shares.

© 2016 McGraw-Hill Ryerson Limited.

 Preferred Shares
Convertible
• Gives holders the option of exchanging their
preferred shares into common shares at a
specified rate.
• Offers holders of convertible shares a higher
potential return.

© 2016 McGraw-Hill Ryerson Limited.

 Preferred Shares
Callable (redeemable)
• The issuing corporation, at its option, may
purchase (retire) these shares from their
holders at specified future prices and dates.
• The amount paid to call and retire a preferred
share is its call price.

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QS 12-12: Dividend allocation between classes of shareholders:

The equity section of the Holden Ltd. balance sheet includes 75,000 shares of
$0.40 cumulative preferred shares that had been issued for $375,000 and
200,000 common shares issued for a total of $720,000. Holden did not
declare any dividends during the prior year and now declares and pays a
$108,000 cash dividend.

a. Determine the amount distributed to each class of shareholders.

b. Repeat the calculations assuming the preferred shares were non-cumulative.

SOLUTION: Quick Study 12-12:

a. Total dividend . ............................................. 108,000

To preferred shareholders ...................... 60,000*
Remainder to common shareholders ..... $48,000
*75,000 shares × $0.40 × 2 years = $60,000

b. Total dividend . ............................................. 108,000

To preferred shareholders ...................... 30,000*
Remainder to common shareholders ..... $78,000
*75,000 shares × $0.40 for current year only = $30,000
Exercise 12-10: Allocating dividends between common and cumulative preferred shares:

The outstanding share capital of Sheng Inc. includes 47,000 shares of $9.60 cumulative
preferred and 82,000 common shares, all issued during the first year of operations.
During its first four years of operations, the corporation declared and paid the
following amounts in dividends:

Determine the total dividends paid in each year to each class of shareholders. Also
determine the total dividends paid to each class over the four years.
Exercise 12-11: Allocating dividends between common and non-cumulative preferred
shares:

Determine the total dividends paid in each year to each class of

shareholders of Exercise 12-10 under the assumption that the preferred
shares are non-cumulative. Also determine the total dividends paid to each
class over the four years.
Exercise 12-12: Identifying characteristics of preferred shares:

Match each of the numbered descriptions with the characteristic of preferred shares
that it best describes. Indicate your answer by writing the letter for the correct
characteristic in the blank space next to each description.

A. Callable or redeemable
B. Convertible
C. Cumulative
D. Non-cumulative
E. Non-participating
F. Participating
______ 1. The holders of the shares can exchange them for common shares.

______ 2. The issuing corporation can retire the shares by paying a prearranged price.

______ 3. The holders of the shares are entitled to receive dividends in excess of the
stated rate under some conditions.
______ 4. The holders of the shares are not entitled to receive dividends in excess of
the stated rate.
______ 5. The holders of the shares lose any dividends that are not declared.

______ 6. The holders of the shares are entitled to receive current and all past
dividends before common shareholders receive any dividends.
 Closing Entries
• Income summary is closed to retained
earnings.
• The cash dividends declared account is closed
to retained earnings (assuming dividends were
not debited to retained earnings when
declared).

© 2016 McGraw-Hill Ryerson Limited.

QS 12-14: Statement of changes in equity, closing entries for a corporation—profit:

Peter Puck Inc. showed the following adjusted information on May 31, 2017, its second
year-end:

a. Prepare the appropriate closing entries.

b. Prepare a statement of changes in equity for the year ended May 31, 2017. No
shares were issued during the second year.
 Review
Discuss the characteristics of corporations.
1. Corporations are legal entities separate and distinct
from their owners.
2. Ownership of corporations is represented by shares.
Owners of the shares are called shareholders or
stockholders.
3. Shares issued by corporations are easily transferable
and shareholders are not personally liable for acts of
the corporation.
4. Corporations are regulated by provincial and federal
governments and are subject to income tax.

© 2016 McGraw-Hill Ryerson Limited.

 Review
Describe the components of equity.
1. Equity is composed of two parts, contributed
capital and retained earnings.
2. Contributed capital consists of funds raised by the
issuance of shares, either common or preferred.
3. Retained earnings consists of current and prior
periods' earnings not distributed to shareholders.

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End of Chapter

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