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Learning objectives
LO1: Describe the characteristics of the corporate form of business.
LO2: Describe the characteristics of equity and how it is recorded and
reported.
LO3: Understand cash dividends, share dividends and share splits.
LO4: Describe the characteristics of preference shares and preference
dividends.
LO5: Describe the characteristics of share buybacks and how they are
recorded and reported.
LO1 Companies
Describe the characteristics of the corporate form of
business.
The corporate form of business has the following characteristics:
Separate legal entity
ability to raise capital
limited liability of owners
transferability of ownership
dividend imputation
regulation.
Transferability of ownership
Another advantage of the corporate form of business is the ease with
which ownership can be transferred, especially shares in publically
listed companies (what you hear about on the news when CBA shares
sell for $60).
When one sole proprietor wants to transfer ownership to another, the
business must be sold.
When a partner wants to transfer an ownership, usually all other
partners must agree.
Dividend imputation
Unlike many countries, Australia does not have double taxation of company
income.
When a corporation is taxed on income, the tax paid is imputed to shareholders
with dividends.
Imagine a company earned $10 000 taxable income and paid $3 000 tax (30%
company tax rate). They then pay the remaining $7 000 in dividends to
shareholders. Assume one shareholder received all the dividends they have the
equivalent pre-tax profit ($10 000) added to their personal income, and pay tax on
that $10 000 at their personal tax rates However, they receive a credit for the $3
000 tax already paid by the company. In this way, we minimise double taxation.
Regulation
Limited liability companies have more regulation.
Publicly traded companies are required to file numerous reports with
ASIC and have their annual report audited.
Companies trading on the ASX are also subject to the continuous
disclosure regime.
Following the Corporate Law Economic Reform Program (CLERP9),
even more disclosures were required by ASIC.
LO2 Shares
Describe the characteristics of equity and how it is
recorded and reported.
One of the distinguishing characteristics of a company is its
ability to sell capital (shares) to investors to raise funds. The
amount raised by issuing capital share is called contributed
capital because the funds are contributed by investors in
exchange for an ownership claim on company assets.
Shareholders rights
When a corporation issues (ordinary) shares, it usually grants
shareholders the following rights:
the right to vote
the right to participate proportionally in dividends
the right to participate proportionally in residual assets (mainly relevant
if company is wound up)
the right of preemption (maintain the same proportion of ownership in
the company).
Issuing shares
Assume that a company issues 100 shares for $5 per share.
The issue will be recorded as follows:
Ledger Accounts
Consider what the ledger accounts (t-accounts) would look
like at the end of the process.
Only Cash and Contributed Capital should have a positive balance.
All other accounts should equal 0
Check if you have made a mistake. Application, Allotment, Call accounts
should all balance out to 0 by the end of the process.
Consider what the Balance Sheet would look like at the end
of the process.
Assets = Cash
Equity = Contributed Capital
LO3 Dividends
Understand cash dividends, share dividends and
share splits.
The goal of any corporation is to generate profits. Once
generated, a company must decide whether or not to distribute
those profits to its owners through dividends. A dividend is a
distribution of profits to owners. A cash dividend reduces the
cash available to pursue other strategies.
Dividends (2)
Dividends are normally paid in cash, but they can also be paid in other
forms such as shares.
When dividends are distributed, they are stated as a per share amount
and are paid only on issued shares.
When and how a company distributes dividends is called a companys
dividend policy.
Cash dividends
The date the board declares the dividend is called the date of
declaration. On this date, the board legally obligates the company to
pay the dividend, so a liability is created.
The boards declaration will also include the payment date and the
date of record. The payment date is the date on which the dividend will
be distributed.
The shares owner on the date of record receives the dividend.
Note how the date of record (21 Nov) has no accounting effect
Share dividends
A share dividend is a distribution of a companys ordinary share to
existing shareholders.
Share dividends are declared by a companys board of directors and
may be stated in percentage terms.
E.g. a 10 per cent share dividend means that the company will issue
additional shares equal to 10 per cent of the current issued shares.
So, an investor owning 10 000 shares will receive 1 000 additional
shares (10 000 X 10%).
No cash outflow for the company!
Share splits
When a company wants to decrease the market price of its share to make it more
affordable, it can use a share split instead of a share dividend.
A share split is an increase in a companys share according to some specified
ratio.
E.g. a company that declares a 2-for-1 split recalls all shares from existing
shareholders and issues two shares in return, effectively doubling the shares
issued. As result of this increased supply of shares, the market price of the share
usually falls proportionally. In a 2-for-1 split, the share price would be cut in half.
This sometimes does not happen, for behavioural finance reasons!
Is it more likely that a $50 share goes up to $55, or a $1.00 share goes up to $1.10? You
may say the latter, but finance says both are theoretically, equally likely!