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BUS 251 Chapter 11 Notes

Business Administration
Course Code
BUS 251
Steve Gibson

of 4
BUS 251 Chapter 11 Notes
Shareholder’s equity
Forms of organization:
Sole proprietorship: single-owner business so that the owner make all the decisions and keep all the profits
o There is no concern to report to the shareholders because they don’t have any
o For taxation purposes owner’s income is recorded as the profit of the company
o There are only capital’s equity in the equity section
Partnership: one or more people own the company and there is a partnership agreement that specifies who
make the decisions in the company and how the assets and profits are distributed
o Capital accounts are used to separate the profits or losses under the owners name
o There is also a drawing account that shows how much money was withdrew from the business by each
of the partner
Corporation: there is a separation from the shareholders legally from the operations. The board of directors are
the people who are decision makers in the business
Limited liabilities differences in the different form of organization
o Sole proprietorship and partnerships have unlimited liability which means that the company assume all
the risk if the business runs into trouble they can get all the debts they want
o Corporate shareholders have limited liability which means they can’t be made to pay for the company’s
debt they can never lose more than what they invested
o Limited partnership have limited liability too :
General partners have unlimited liability and they make day-to-day decisions
Limited partners have limited liability and they have limited involvement in the partnership
Taxation differences in different forms of organization
o For partnership or sole proprietorship companies their taxes are included with their person tax
o For corporate income taxes, tax are doubled but doesn’t mean that they have to pay more.
o Tax are paid by the amount of income they earn and also the dividends they issued
Transfer of ownership is easier for corporation but there are cost to file corporate income tax returns…etc.
A corporate company can get incorporated to protect the shareholders because they are not making the
decisions for day-to-day activities
Articles of incorporations include all the information how the business will be run and who are people
responsible for what kind of decisions
The article of incorporation states the authorized shares (the maximum number of shares that the company can
Issued shares: shares that the company has sold
Par value: the dollar amount that is attached to each share
Legal capital: when shares are issued the total amount must be keep intact and it cannot be paid out as
dividends to protect the creditors and prevent liquidating dividend
Prospectus: the legal document that shows the details and features of issued common/preferred shares
Common shares
Common shares: represent basic voting ownership rights of the company
Basic set of rights that allow the owner to share proportionately:
Profits and losses
o Different classes of shares are entitled to different portions of the earnings
o No restrictions on their rights to share in earnings
o The company’s profits and losses are allocated to its shares measured by earnings per shares figure
Selection of corporate management
o The right to vote for the corporation’s board of directors (one share = one vote)
o The board of directors represent shareholders and make decisions and pay dividends
BUS 251 Chapter 11 Notes
Net assets upon liquidation
o If the company goes bankrupt there is a order in which creditors and shareholders are paid
o Common share has the highest risk because: paid orders are creditors + preferred shareholders first
Subsequent issues of shares
o The rights for the shareholders to retain their proportionate interest in the company when new shares
are issued (pre-emptive right)
o Controlling interest: when new shares are issued to another investor they lose the interest
Multiple classes of shares
o Each class is distinguish by some amendment to the fundamental rights of common shares
o Different voting features and rights
Preferred shares
Preferred shares: shares that have preference over common shares with regard to dividends which mean
dividends will be received first before common shares and net assets if the company liquidate
o Preferred shares are non-voting
Cumulative: if dividends are not paid this year then it will be paid next year adding on the previous year amount
and before common shares dividends are paid
o Dividends in arrears: dividends from prior year that have not been paid
Convertible: shareholder can convert preferred shares to common shares with certain conditions
Redeemable: shares that can be bought back by the company at a set price and time so company can re-issue it
at a higher rate
Retractable: shareholders can sell back the shares to the company at a set price
Participating: when dividends declared to common share is more than preferred shares then shareholders will
get the higher one
Accounting for issuance of common shares
Paid-in capital: common shares are issued for cash
Contributed capital: when there is a difference between the par value and per share value
Repurchased shares
Earnings per share rises if the company buy back its shares because income is divided less shares
Treasury shares: shares that have been repurchased by the issuing company
o Repurchased shares must be cancelled immediately after the company repurchase them
Outstanding shares: shares that are in possession of shareholders
Dividends, stock splits, and employee stock options
Cash dividends
Dividends are payments to shareholders from the net earnings retained by the company in RE account because
company used shareholder’s money to operate
Company will not paid treasury shares and can only pay outstanding shares
Dividend declaration is when the board of directors votes to declare dividends and company report as
dividends payable in the future
Date of record is the date that the dividends will be payable to the shareholder
o Ex-dividend day: the day that the shares are sold without the rights to received dividend
Date of payment: the day that the company pays its dividends (reduce cash and liability)
Property dividends
Property dividends is when the company declare dividends to be paid not in cash but by other resources
Recorded at fair market value on the declaration date
Stock dividends
Stock dividends: dividends that are pay by additional company shares rather than cash or property when
company doesn’t want to use cash or other resources
Company’s overall value and the percentage ownership of each shareholder have not changed
BUS 251 Chapter 11 Notes
No decrease in RE account and capital account increases
Stock dividends are valued at its market value on the date of declaration because it is small stock dividend
Transfer of retained earnings to common shares to increase legal capital
Shareholders are better off because company can capitalize its retained earnings and per share book value is
lower but market value is not fully reduced
Stock splits
Stock splits is when 1 share is split into many shares so no value is added but the outstanding share is adjusted
This will only increase outstanding shares when the prices of each shares are too high and no one in the market
is willing to buy it so company split shares but otherwise there will be no change in value of capital
Employee stock options
Stock option: common shares between 2 parties to either buy or sell shares at a fixed price in the future
Exercise price is the fixed price for shares
Expiration date is when the stock option cannot be exercised anymore
Vesting period: the period that the employee must work for the company in order for them to exercise the
stock option but the option is not for trade because it is restricted to whom it was issued to
Example: Using the black-scholes model the company estimated that the exercised price will be $30x5000
shares = 150,000$ and total fair value of $2000x3 years = $6000 (DR compensation expense per year) but when
the executive exercise the share trading at $38x5000 shares = $190,000 he earned 4000$ and the company
increase its common shares outstanding. Contributed surplus of $6000 is transferred over.
Statement of retained earnings and statement of changes in equity
Statement of retained earnings:
Retained earnings beginning + net earnings/income dividends declared = retained earnings ending
If there are corrections and errors from the previous period then it should not be recorded in RE
Statement of changes in equity
Show all the changes in equity accounts with rows summarizing the transaction occurred during the year with
previous year in the top and this year in the bottom
Accumulated other comprehensive income is the changes in those equity accounts over the period
Contributed surplus is affected by the repurchase of shares
Gains or losses incurred are reported as other comprehensive income but no net earnings then added to net
earnings to determine the total comprehensive income for this year
Balance sheet records the accumulated other comprehensive income that record the gain or losses affect
shareholder’s wealth = beginning balance + gains/losses with other comprehensive income = ending balance
recorded under the shareholder’s equity
Financial statement analysis
Book value and market value
Book value is the shareholder’s equity represents the net assets based on accounting books
o Investments principal amount + retained earnings + accumulated other comprehensive income
o Represent the value of shareholder’s investment based on the conventions of the accounting model
(historical cost valuation for assets
Market value: measured by multiplying the market price per shares by outstanding share #
o Include goodwill and intangible assets
Price/earnings ratio:
o Price/earnings ratio = 
o If the company’s current future earnings are expected to grow then market price per share will increase
faster than earnings per shares
Return on shareholder’s equity ratio: