2/18/2009. Reporting and THE CORPORATE FORM OF ORGANISATION. Characteristics of a corporation. Chapter 10. A corporation:

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1 Chapter 10 Reporting and analysing equity PowerPoint presentation by Anne Abraham University of Wollongong 2009 John Wiley & Sons Australia, Ltd THE CORPORATE FORM OF ORGANISATION A corporation: Is created by law Has most of the rights and privileges of a person (but not voting or holding office) Is subject to the same duties and responsibilities as a person (including keeping the law and paying taxes) Companies are the most common type of corporation 2 Characteristics of a corporation Separate legal existence Limited liability of shareholders Transferable ownership rights Continuous life Ability to acquire capital Company managed through elected board of directors Subject to government regulations 3 1

2 Forming a company A company is formed by registration and bound by the Corporations Act Each company is allocated an ABN and an ACN A company may adopt a constitution set of rules governing internal management If no specific constitution is adopted, a company is automatically subject to the replaceable rules of the Corporations Act 4 Shareholder rights A company is owned by its shareholders Different classes of shares carry different ownership rights Ordinary shares Preference shares When a company has only one class of shares they are referred to as ordinary shares 5 Shareholder rights continued Ordinary shares have 3 major ownership rights: Right to vote Right to share in company s profit Right to a residual claim if company is liquidated Preference shares have priority over ordinary shares with respect to dividends and claims at liquidation 6 2

3 SHARE ISSUES A company receives cash in exchange for issuing shares When a company decides to issue shares, it must decide: How many shares How shares should be issued At what price the shares should be issued 7 Issue of shares Private placement involves issue of shares to certain private investors by invitation Public issue requires a prospectus p inviting public application for shares The prospectus: Reports on the company s financial position, performance and plans Contains reports from independent parties 8 Issue of shares continued Factors influencing the issue price for a new issue of shares are: The company s anticipated profits The company s expected dividend rate per share The company s current financial position The current state of the economy The current state of the securities market 9 3

4 Accounting for the private issue of shares When shares are issued by private placement, the proceeds are immediately available for use by the company Journal entry to record private placement: Sep 30 Cash Share Capital (To record issue of 1000 shares at $1 each) 10 Accounting for the public issue of shares Prospectus investors return application form with application money for the number of shares they want Journal entry on application: Sep 30 Cash Trust Application (To record receipt of application money for shares issued with $0.50 per share due on application and $0.20 on allotment) 11 Accounting for the public issue of shares continued Application money is held in trust until the allotment (or issue) of shares Journal entries on allotment: Oct 1 Application Share Capital (To record application money as share capital on allotment of shares to applicants) Allotment Share Capital (To record amounts owing on allotment of shares) 12 4

5 Accounting for the public issue of shares continued Company can now transfer money received from trust account into its own bank account Oct 1 Cash at Bank Cash Trust (To record transfer of application money to the company s bank account on allotment of shares) Journal entry to record payment of allotment money Oct 31 Cash at Bank Allotment (To record receipt of monies due on allotment) 13 Accounting for the public issue of shares continued At times companies require full payment on application At other times companies only require part payment on application with the remainder due on allotment or subsequent calls on capital A call on capital is when a company asks shareholders to pay some or all of the unpaid capital on issued shares 14 Share splits A share split involves the issue of additional shares according to the percentage ownership of shareholders This results in a reduction in the stated value per share e.g. a 2-for-1 split means that one share with a value of $10 will be exchanged for 2 shares each with a value of $5 A share split does not affect the total equity of the company 15 5

6 Share splits continued The purpose of a share split is to increase the marketability of the shares by lowering the market price per share The effect of a share split is usually inversely proportional to the size of the split e.g. After a recent 3 for 1 share split the market value of CSL shares fell from $ to approximately $35 16 DIVIDENDS A dividend is a distribution of profit by a company to its shareholders on a pro rata basis Forms of dividends: Cash Property Shares Public companies often pay 2 dividends: Final dividend determined at end of year Interim dividend paid during the year 17 Cash dividends A cash dividend is a pro rata distribution of profit paid in cash to shareholders To pay a cash dividend, a company needs: Adequate retained earnings Adequate cash available to avoid insolvency Dividends declared by directors 18 6

7 Cash dividends continued Journal entry when dividend is declared Dec 1 Retained Earnings (or Cash Dividends Declared) Dividends Payable (To record declaration of cash dividend) Journal entry when dividend is paid Jan 20 Dividends Payable Cash (To record payment of cash dividend) 19 Share dividends A share dividend is a pro rata distribution of the company s shares to shareholders Total equity does not change because: Retained earnings decreases and Share capital increases A share dividend signals that this amount of retained profits is not available to shareholders as cash dividends 20 Share dividends continued Journal entry when dividend is declared Dec 1 Retained Earnings (or Share Dividends Declared) Share Dividends Payable (To record declaration of 10% share dividend) Journal entry when dividend is paid Jan 20 Share Dividends Payable Share Capital (To record the issue of 5000 $15 shares as a share dividend) 21 7

8 REPORTING ON EQUITY Equity section of the statement of financial positon of a corporation includes: Share capital: contributed equity (paid and any outstanding amounts) Retained earnings: prior profits kept within company and not distributed as dividends Reserves: changes in equity not created through transactions with owners 22 REPORTING ON EQUITY continued BILLABONG INTERNATIONAL LIMITED Balance Sheet as at 30 June 2007 (extract) Equity $ 000 Contributed t equity $ Treasury shares (19 708) Option reserve Other reserves (21 940) Retained profits Parent entity interest $ Share capital The amount of share capital (contributed equity) must be shown on the face of the balance sheet Other information on share capital may be found in the notes to financial statements 24 8

9 Share capital continued For each class of shares, a company must provide: The number of fully paid shares The number of partly paid shares An explanation of any changes in number of shares during the year 25 Reserves Most reserves of Australian companies are classified as revenue reserves and can be distributed as dividends Companies must: Show the aggregate amount of reserves on the face of the balance sheet Disclose the nature and purposes of reserves Provide a reconciliation that explains movements in each reserve during year 26 Retained earnings Retained earnings represent accumulated profits that have not been distributed to shareholders as dividends On the statement of financial position, companies must report: The opening amount of retained earnings Changes to retained earnings during the year The amount of retained earnings at balance date 27 9

10 FINANCIAL STATEMENT ANALYSIS AND DECISION MAKING Dividend record The dividend payout rate measures the percentage of profit distributed in the from of cash dividends to ordinary shareholders Cash dividends declared on ordinary shares Profit Example ($ in millions) Foster s $504.4 = 451.6% $474.2 = 49.1% Group $111.7 $ FINANCIAL STATEMENT ANALYSIS AND DECISION MAKING continued Earnings performance Return on shareholders equity shows how many dollars of profit were earned for each dollar invested by ordinary shareholders Profit preference dividends. Ordinary shareholders average equity Example ($ in millions) Billabong $ $0 = 22.7% $ $0 = 22.8% ($ $757.6)/2 ($ $710.4)/2 29 DEBT VERSUS EQUITY FINANCING DECISIONS Debt financing has 3 major advantages over equity financing: 1.Shareholder control is not affected Noteholders do not have voting rights, so shareholders retain full control of company 2. Tax savings result Interest is deductible for tax purposes while dividends on shares are not 30 10

11 If a business requires additional finance but is not sure whether to use debt or equity what factors should be taken into consideration? 31 DEBT VERSUS EQUITY FINANCING DECISIONS continued 3. Return on equity may be higher Although interest expense reduces profit, return on shareholders equity is often higher under debt financing because equity is not increased by the issue of shares 32 Decision Toolkit Lion Nathan Limited Work through on your own and check your results with the suggested solution provided 33 11

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