Equity

Question 1

A company selling shares is … required to repay the capital to its public investors

Answer 1

never

Question 2

Shares represent residual corporate interest that …

Answer 2

• … bears the risks of the losses
• … receives the benefits of success
• … no guaranteed dividends or assets upon dissolution.

Question 3

Ordinary shares

Answer 3

Represent the basic ownership interest.
- To share proportionately in profits and losses
- To share proportionately in management (right to vote).
- To share proportionately in new issues of shares (preemptive right).

Question 4

Preference shares

Answer 4

Sacrifice certain basic rights in return for other special rights:
- Preferred dividends (cumulative and non-cumulative)
- No voting rights (not always)
- Alternatively: more rights per share
- Convertible in ordinary shares
- Callable firm

Question 5

Equity

Answer 5

Residual interest in the firm’s assets after deducting all liabilities.

Question 6

Two primary sources of equity

Answer 6

• Contributed capital (Ordinary/Preference shares: share premium)
• Retained earnings

Question 7

Two types of issuance:

Answer 7

• at “par value” : company maintains two accounts separately for preference and ordinary shares.
• at “non-par value” : just the account (share capital)

Question 8

Costs of issuing shares:

Answer 8

• Direct costs: underwriting costs, accounting/legal fees
• Reduction of the amount paid-in -> debit to share Premium (no recording of expense)

Question 9

Lump-sum sales

Answer 9

• Issuing two or more classes of securities for a single payment.

Question 10

2 ways to account for lump-sum

Answer 10

• Proportional: allocate lump sum on a proportional basis of fair values.
• Incremental method: allocate first securities with known fair value, rest to the class without fair value.

Question 11

Shares issued in non-cash transactions

Answer 11

• ## shares issued in exchange for services or property other than cash.

Question 12

What are the benefits/incentives for coporations to purchase their outstanding shares back?

Answer 12

• To provide tax-efficient distributions of excess cash to shareholders.
• To increase earnings per share and return on equity.
• To provide shares for employee compensation contracts or to meet potential merger needs.
• To better fight hostile takeover attempts or to reduce the number of shareholders.
• To make a market in the shares.

Question 13

What happens after re-acquiring?

Answer 13

either:
- Shares are retired, OR
- Shares are held in “treasury” account -> treasury shares

Question 14

Facts on treasury shares

Answer 14

Treasury shares are not an asset!
- Reduction in assets and equitity
- No voting rights
- Basically the same as unissued ordinary shares.
Treasury shares may be re-issued.

Question 15

Treasury shares: cost method

Answer 15

idea: account for the cost of buying back the shares.

Debit : “treasury shares (bs) account
Credit : “Cash (bs) account

Report “treasury shares” account as a deduction from equity on the balance sheet. (contra-equity account).

Question 16

What happens when a company sells treasury shares?

Answer 16

3 scenarios :
- At cost:
debit “cash” + credit “treasury shares”

• Above cost:
  debit “cash” + credit “treasury shares & Share premium-treasur “
• Below cost:
  debit “cash & share-premium-treasury”
  credit “treasury shares”

Important!!!! Below cost is only possible if there is enough credit in the “Share Premium-Treasury” . Otherwise: debit any additional excess of cost over selling price to the “Retained earnings”.

Question 17

What does retiring shares mean?

Answer 17

Decision results in :
- cancellation of the treasury shares and
- a reduction in the number of shares of issued shares.

Question 18

What does cancelation mean?

Question 19

What does cancelation mean?

Answer 19

• Retired treasury shares have the status of authorized and unissued shares
• Company does not need approval from its shareholders to issue new shares and capital based on retired treasury shares.

Question 20

Give 4 types of dividends

Answer 20

1. Cash dividends
2. property dividends
3. liquidating dividends
4. Share dividends

Question 21

Few companies pay dividends in amounts equal to their legally available retained earnings. WHY?

Answer 21

• Maintain agreements with creditors (debt covenants)
• To finance growth or expansion
• To smooth out dividend payments
• To build up a cushion against possible losses

Question 22

Cash dividends: what are the 3 steps

Answer 22

1. declare
2. record (do nothing)
3. payment

Question 23

Cash dividends : date of declaration

Answer 23

debit retained earnings
credit dividend payable

Question 24

Cash dividends : date of payment

Answer 24

debit dividends payable
credit cash

Question 25

Property dividends : date of declaration

Answer 25

debit :
- equity investment
- retained earnings
credit:
- unrealized holdings gain/loss - income
- property dividends payable

Question 26

Property dividends: date of payment

Answer 26

debit:
- property dividends payable
credit:
-equity investments

Question 27

What is the key difference between liquidating dividends and cash/property dividends?

Answer 27

• Liquidating dividends not based on retained earnings.
• Instead, they reduce share premium/share capital accounts.

Question 28

Liquidating dividends : date of declaration

Answer 28

debit:
- retained earnings (0.5x)
- share premium (0.5x)
credit:
- dividends paybale x

Question 29

Liquidating dividends : date of payment

Answer 29

debit:
- dividends payable
credit:
- cash

Question 30

Share dividends : declaration date

Answer 30

debit:
- retained earnings
credit
-share dividend distributable (EQ)

Question 31

Share dividends : date of payment

Answer 31

debit
- share dividend distributable
credit:
- share capital

Question 32

What happens with a share splits

Answer 32

• Firm does not distribute earnings via dividends -> retaining earnings increases -> share price increases.
• consequence: shares are less accessible to investors due to high share price.
• no journal entry needed.

Question 33

Formula lump-sum

Answer 33

factor = FV * nbr of shares / total lumpsum

Question 34

Record the adjustment of the carrying value of the portfolio.

Answer 34

debit:
- investment - trading securities
Credit:
- unrealized gain (loss) income.