Chapter 13: Intro to Corporations

Question 1

What is a corporation?

Answer 1

A legal entity that is separate from its owners, who are known as shareholders

Question 2

Corporations are classified by…

Answer 2

1) Purpose: Profit or non-profit organization
2) Ownership: Public or private corporation

Question 3

What is a public corporation?

Answer 3

A corporation whose shares are available for purchase on an organized securities market

Question 4

What is a private corporation?

Answer 4

A corporation whose shares are held by a few individuals and are not traded

Question 5

What are characteristics of a corporation?

Answer 5

1) Separate legal existence:
- Acts under its own name
- May buy, own, and sell property
- Owners do not bind the corporation
- Pays income tax as a separate legal entity

2) Limited liability of shareholders
- Liability of each shareholder is limited to the amount of their investment

3) Transferrable ownership rights
- Shares may be bought or sold
- Has no effect on operating activities of corporation

4) Ability to acquire capital
- Can raise capital by issuing shares
- Only small amounts of money need to be invested
- May be difficult to reacquire capital for private corporations

5) Continuous and unlimited life
- Unaffected be change in ownership

6) Government regulations
- Specific laws that govern the operations of corporations (e.g. issuing shares, distributing income, etc. )

7) Income tax
- Taxed as a separate entity
- Lower income tax rates
- Profit is reported on the partner’s personal income tax return

Question 6

What is the disadvantage of corporations?

Answer 6

Increased cost and complexity to follow government regulations

Question 7

How do you form a corporation?

Answer 7

• Can incorporate federally or provincially
• Done by filing articles of incorporation

Question 8

What are bylaws?

Answer 8

Internal rules and policies for operations

Question 9

What are organization costs?

Answer 9

Costs incurred in the formation of a corporation
(e.g. legal fees, accounting fees, registration costs)

Question 10

Ownership rights are in the form of…

Answer 10

Shares, that can be divided into different classes.

• Stated in the articles of incorporation
• Each class has rights and privileges
• Usually referred to as common and preferred shares

Question 11

Shareholders have rights…

Answer 11

1) To vote on certain matters (e.g. election of board of directors, appointment of external auditors)

2) To dividends: the distribution of profit

3) To remaining assets in a liquidation

Question 12

How do shareholders manage the corporation?

Answer 12

Indirectly through the board of directors that they elect

Question 13

What do the board of directors do?

Answer 13

• Decides on the corporation’s operating policies
• Selects officers (e.g. Chief Executive Officer (CEO) ) to execute policy and perform daily management functions

Question 14

How is profit distributed in corporations?

Answer 14

Profit can either be reinvested in the company or distributed to shareholders as dividends

Question 15

What is a dividend?

Answer 15

A distribution of profit by a corporation to its shareholders on a pro rata basis

Question 16

What is pro-rata?

Answer 16

Based on the proportion of shares owned

Question 17

What is share capital?

Answer 17

Amounts paid or contributed to the corporation in exchange for shares of ownership

Question 18

What is authorized share capital?

Answer 18

Total number of each class of shares a corporation is allowed to sell

Question 19

What is issued shares?

Answer 19

The authorized shares that have been sold to investors

Question 20

How can a corporation issue common shares?

Answer 20

• Directly to investors
• Indirectly through an investment dealer

Question 21

What is the initial public offering?

Answer 21

The first public sale of a corporation’s shares

Question 22

What happens when the taker value of shares are issued?

Answer 22

• Once issued, shares trade on a secondary market
• Prices are determined by buyers and sellers and other external factors

Question 23

What is legal capital?

Answer 23

The share capital that must be retained in the business for the protection of corporate creditors

Question 24

What is the difference between share capital and retained earnings?

Answer 24

1) Share capital is legal capital and cannot be distributed to shareholders

2) Retained earnings are earned capital and can be distributed to shareholders as dividends

Question 25

What is no par value shares?

Answer 25

Share capital that has not been given a specific value. All proceeds from the sale are treated as legal capital

Question 26

What are common shares?

Answer 26

Shares whose owners have the right to: - Vote on the election of the board of directors - Share in the distribution of profit through dividends - Share any assets that remain after liquidation - Corporation has only one class of shares

Question 27

Under IFRS, what do you do if the fair value of goods/services is not measurable?

Answer 27

Use fair value of shares given in exchange

Question 28

Under ASPE, what do you do fair value of goods/services is not measurable?

Answer 28

Value the transaction at the amount that can be more reliably measured

Question 29

What are preferred shares?

Answer 29

Shares that have a priority over common shares for dividends be assets in the event of liquidation of the company

Question 30

What are the characteristics of preferred shares?

Answer 30

- Generally have no vote - Entries to record issue and reacquisition of preferred shares is similar to common shares - Annual dividend rate is specified in the articles of incorporation - Transactions for each class of share is recorded in a separate account

Question 31

What do cumulative preferred shares have a right to?

Answer 31

The current year’s dividends and any prior year’s dividends owing before dividends are paid on common shares

Question 32

What are dividends in arrears?

Answer 32

Dividends on cumulative preferred shares that were not declared

Question 33

What are non cumulative shares?

Answer 33

Preferred shares that are entitled to the current dividend, but not to any unpaid amounts from previous years. Shares are gone if not paid

Question 34

What are convertible preferred shares?

Answer 34

Preferred shares that the shareholder can convert into common shares at a specific ratio

Question 35

What are retained earnings?

Answer 35

The cumulative total of profit less losses and less declared dividends since incorporation. It represents part of a shareholder’s claim on total assets of a corporation, not a claim on any specific asset (including cash) Two major components on the statement: Profit and dividends

Question 36

What’s one major difference for a corporation’s income statement?

Answer 36

Income tax. Because a corporation is a separate legal entity. It affects the income statement and balance sheet

Question 37

What are cash dividends?

Answer 37

Distribution of cash on a pro rata basis to shareholders

Question 38

What are stock dividends?

Answer 38

Distribution of the corporation’s own shares to shareholders (normally common shares)

Question 39

To pay dividends, a corporation must…

Answer 39

1) Have enough retained earnings and cash 2) Maintain legal capital 3) Declare a dividend payable

Question 40

What are the three important dates for dividends?

Answer 40

1) Declaration date - Board of directors formally declares dividend - Commits corporation to a legal obligation 2) Record date - Ownership of shares is determined - Shareholders of record on this date will record dividends - No journal entry required 3) Payment date - Dividend is paid to shareholders and recorded

Question 41

Are dividends in arrears considered a liability?

Answer 41

Dividends in arrears are not considered a liability. No obligation to pay dividend until board of directors declared. It is disclosed in the notes to financial statements

Question 42

What does the statement of retained earnings show?

Answer 42

The statement of retained earnings show the changes in retained earnings during the year. It is required under ASPE.

Question 43

What are transactions that affect retained earnings?

Answer 43

- Earning a profit - Declaring cash and stock dividends - Other transactions

Question 44

What is contributed capital?

Answer 44

The total amount contributed by shareholders

Question 45

What is share capital?

Answer 45

Consists of preferred and common shares

Question 46

What is contributed surplus?

Answer 46

Amounts contributed from acquiring and retiring shares

Question 47

What is return on equity and how is it calculated?

Answer 47

Return on equity evaluates how many dollars are earned for each dollar invested by shareholders. It is considered to be the most important measure of a firm’s profitability Profit / Average Shareholder’s Equity = Return on Equity