Chapter 15 Equity

THE CORPORATE FORM OF ORGANIZATION The special characteristics of the corporate form that affect accounting include: 1. Influence of corporate law. 2. Use of the share system. 3. Development of a variety of ownership interests. Corporate Law Articles of incorporation must be submitted to the appropriate governmental agency for the country in which incorporation is desired. Many governments have their own bussiness incorporation act. The accounting for equity follows the provisions of these acts. Share System Equity in a corporation generally consists of a large number of units or shares. Within a given class of shares, each shares exactly equals every other share. Each share has certain rights and privileges. Only by special contract can a company restrict this rights and privileges at the time it issues the shares. In the absence of restrictive provisions, each share carries the following rights: 1. To share proportionately in profits and losses 2. To share proportionately in management (the right to vote for directors) 3. To share proportionately in corporate assets upon liquidation 4. To share proportionately in any new issues of shares of the same class called the preemptive right The preemptive right protects an existing shareholder from involuntary dilution of ownership interest. Variety of Ownership Interest Ordinary Shares represent the residual corporate interest that bears the ultimate risks of loss and receives benefits or succes. Preference Shares represent the special contracts between the corporation and its shareholders, however, the shareholders may sacrifice certain of these rights or privileges. Equity

Equuity is the residual interest in the assets of the company after deducting all liabilities. Companies often make a distinction between contributed capital and earned capital. Contributed capital is the total amount paid in on capital shares - the amount provided by shareholders to the corporation for use in the bussiness. Earned capital is the capital that develops from profitable operations, consists of all indistributed income that remains in the company. Issuance of Shares Procedures in issuing shares: 1. The applicable governmental agency must authorize the share, generally in a certificate of incorporation or charter. 2. The corporation offers shares fo sale, entering into contracts to sell these shares. 3. After receiving amounts for the shares, the corporation issues the shares.

Accounting for Par value Shares The par value of a share has no relationship to its fair value. To show the required information for issuance of par value shares, corporations mantain accounts for each class of shares as follows: a. Preference Shares or Ordinary Shares. The company credits these accounts when it originally issues the shares. b. Share Premium. This account indicates any excess over par value paid in by shareholders in return for the shares issued to them. Accounting for No-Par Shares The reasons for issuance of shares of no-par shares are: (1) Issuance of no-par shares avoids the contingent liability that might occur if the corporation issued par value shares at a discount, (2) some confusion exists over the relationship between the par value and fair value. A major disadvantage of no-par shares is that some countries levy a high tax on these issues. True no-par shares should be carried in the accounts at issue price without any share premium reported. Most corporations account for no-par shares with a stated value as if they were par value shares with par equal to the stated value. Accounting for Shares Issued with Other Securities (Lump-Sum Sales)

The accounting problem in sucg lump-sum sales is how to allocate the proceeds among the several classes of securities. Companies use one of two methods of allocation: (1) the proportional method: The company allocates the lump sum received among the classes of securities on a proportional basis. (2) the incremental method: The company uses the fair value of the securities as a basis for those classes that it knows, and allocates the remainder of the lump sum to the class to which it does not know the fair value. If a company cannot determine fair value for any of the classes of shares involved in a lump-sum exchange, it may need to use other approaches. Accounting for Shares Issued in Non-Cash Transactions Companies shouls record shares issued for services or property other than cash at the fair value of the goods or services received, unless that fair value cannot be measured reliably. If the fair value of the goods or services cannot be measured reliably, use the fair value of the shares issued. If a company can readily determine both, and the transaction results from an arms-lenghth exchange, there will probably be little difference in their fair values. If a company cannot readily determine either the fair value of the shares it issues or the property or services it receives, it should employ an appropriate valuation technique. The overvaluation of equity resulting from inflated asset values creates watered shares. The undervaluation of the recorded assets creates secret reserves.