Shareholders Equity

COMR 457
Chapter Eleven
Reporting and Interpreting Shareholders’ Equity
We have now completed our review of the asset and liability sections of
the Statement of Financial Position. Let’s now turn our attention to the
Shareholders’ Equity or the net assets section. A company may have
been incorporated under either Provincial or Federal Company Act.
Remember that a corporation is a separate legal entity from its
shareholders. It may enter into contracts and is responsible for filing its
own tax returns. Unlike a lender who loans money to the company (i.e.,
a bondholder from Chapter 10) and expects to be repaid, an investor
who purchases shares in a company is making a permanent
investment in the company. The company is under no obligation to
repay any investment made by the shareholder. The shareholder is free
to sell his/her shares to another party. The benefits of being a
shareholder are summarized on pages 11-11 to 11-12.
While some companies have more than one class of shares, most have
only one class of shares known as common shares. In this case, each
shareholder must receive equal treatment. Each share entitles the
shareholder to one vote at shareholder meetings.
Shares may be issued for cash, assets or services. Shares should be

recorded at the fair market value of the shares issued or the value of the
consideration received by the company, whichever is more reliable. The
maximum number of shares which a company may issue is known as
the authorized number of shares. This number is specified in a
company’s incorporating documents. The number of shares which have
been issued by the company is known as the issued number of shares.
The number of shares which are issued and held by external
shareholders is known as the outstanding number of shares.
© Scott M. Sinclair, FCPA, FCA 2022 1

COMR 457
Issuance of Shares
When common shares are issued, the journal entry is:
Dr Cash
Cr Common shares
The full amount for any consideration received is recorded in the

Common shares account.
When an investor purchases shares of a company they may have many

objectives including gaining control of the company, profiting from an
increase in the price of the shares and/or receiving periodic dividend
income from their investment. The directors of the company will
determine whether any dividend payments will be made. The directors
are under no legal obligation to declare dividends. However, most
investors expect and appreciate dividend payments.

COMR 457
Cash Dividends
There are three important dates with respect to dividends:
Date of Declaration – the date the dividend is declared by the

Board of Directors and becomes a liability of the company.
Date of Record – the date that the recipient of the dividend is

determined – i.e., the registered shareholder who is entitled to
receive the dividend.
Date of Payment – the date the payment is actually made to the

shareholder.
Notice that the date of record is not usually the same day as the date of
declaration. This is because large companies which have active share
trading need time to ensure their share capital records are properly
updated. A dividend can only be paid if the company has the cash
necessary to make the payment and the dividend does not render the
company insolvent. The journal entry on the declaration date is:
Dr Dividends declared or Retained Earnings

Cr Dividends payable
Dividends declared is not an expense but rather a distribution of

Retained Earnings. Therefore, it appears on the Statement of Retained
Earnings. Some textbooks debit Retained Earnings as opposed to
Dividends declared. I prefer to use Dividends declared so that opening
Retained Earnings always equals ending Retained Earnings from the
previous year.

COMR 457
Cash Dividends continued
On the date of record, no entry is necessary however the company now

can establish the name of each shareholder entitled to a dividend
payment. Remember each share must receive the same amount of
dividend payment.
On the payment date the journal entry is:
Dr Dividends payable
Cr Cash
Stock (Share) Dividends
Although a company may have Retained Earnings (i.e., past earnings

which have been retained by the company), it may have little cash or no
desire to distribute any of its cash. In such cases, the Board of Directors
may wish to make a distribution of Retained Earnings in the form of
additional common shares. Essentially a portion of Retained Earnings
will be reclassified to Common Shares – often referred to as
capitalization of Retained Earnings. Each shareholder will receive a
proportionate share of the additional shares issued. Because a Stock
Dividend is issuable to each shareholder, each shareholder maintains
their present % ownership interest in the company (i.e., a shareholder
who holds a 10% interest in the company before the stock dividend will
hold a 10% interest after the stock dividend). As there are now more
shares outstanding, the market price of each share will likely drop.
However, as each shareholder owns more shares, the value of their total
investment should remain relatively unchanged.

COMR 457
Stock Dividends continued
Assume a company declares a 10% stock dividend. The journal entry on

the date of declaration is:
Dr Stock dividends declared/Retained Earnings

Cr Common shares issuable
The amount of the entry is determined as follows:
= Number of common shares currently outstanding * 0.10 *Current

Market value of one common share on the date of declaration.
Common shares issuable is not a liability as no assets of the company

will be used to satisfy the obligation - rather additional common shares
will simply be issued. The account is part of Shareholders’ Equity. As
with cash dividends, no journal entry is necessary on the date of record.
When the additional shares are distributed (i.e., date of issuance) the
following entry is necessary:
Dr Common shares issuable

Cr Common shares
Notice that the effect of these two entries is:
Dr Stock dividends declared/Retained Earnings

Cr Common shares

COMR 457
Stock Splits
In good economic times, a company may split its stock. A stock split is
not a dividend. Generally, companies split their stocks in order to make
the shares more affordable for investors. A stock split will result in a
decrease in the market price of a company’s stock. Far more investors
can purchase a $10 stock than a $100 stock. As with dividends, the
Board of Directors must approve and announce a stock split. Assume a
company announces a 3 for 1 stock split. Each shareholder will be
entitled to receive a further 2 shares from the company for each share
they currently own. Notice that the numbers of issued and outstanding
shares will increase - at the conclusion of the stock split, the company
will have three times as many shares issued and outstanding as before
the stock split. There is no journal entry to record the entry but rather
the number of issued and outstanding shares will be revised.
Preferred Shares
As noted above, a company may have more than one class of shares
outstanding. Each class will entitle the shareholder to different rights.
Preferred shareholders usually have a preference for receiving
dividends before common shareholders. Most have a fixed dividend rate
or amount but do not have voting rights. Investors in preferred shares
are looking for annual dividend income and are usually more risk averse
than common shareholders. Pages 11-13 to 11-17 does a good job of
discussing other features that may be attached to preferred shares. The
accounting issue that arises when both common and preferred shares
are outstanding is determining who is entitled to any dividends declared.
In order to make a proper determination, one must determine whether
the preferred shares carry a cumulative or non-cumulative feature.

COMR 457
Preferred Shares continued
Most preferred shares have a cumulative right for dividends. A

cumulative feature means that the right to receive a dividend for a year
is retained by the preferred shareholder even if no dividend is declared
for that year. The amount in respect of dividends on cumulative preferred
shares which have not been declared in prior years is known as
dividends in arrears. These amounts are not shown as liabilities as
there is no legal obligation to pay them (i.e., they have not been
declared). However, dividends in arrears should be disclosed in the
notes to the financial statements as common shareholders should be
aware that these dividends would have to be paid prior to the distribution
of any dividends to common shareholders. Should preferred shares be
noncumulative, they are only entitled to the dividend declared in the
current year. There is no such thing as dividends in arrears on
noncumulative preferred shares or common shares.
Repurchased Shares
Occasionally a company may wish to repurchase its own common

shares. In Canada, repurchased shares usually cancelled.
In accounting for the acquisition and cancellation of a company’s own

shares, there are three scenarios which may arise:
The shares are repurchased for an amount that is equal to the

average issue price of the shares repurchased.
The shares are repurchased for an amount that is less than the
The shares are repurchased for an amount that is more than the

COMR 457
Repurchased Shares continued
Any gain or loss realized on the above noted transactions is

referred to as a capital transaction and is never recorded on the
Income Statement.
The journal entries for each of the above noted scenarios are:
Shares purchased at average issue price:
Dr Common Shares
Cr Cash
Shares purchased at a price less than the average issue price:
Dr Common Shares
Cr Cash
Cr Contributed Surplus (part of Shareholders’ Equity)
Notice that any gain is credited to an account known as Contributed

Surplus (part of Shareholders’ Equity).
Shares purchased at a price more than the average issue price:
Dr Common Shares
Dr Contributed Surplus (eliminate any balance in this account)
Dr Retained Earnings (any difference is charged to Retained Earnings)
Cr Cash

COMR 457
Repurchased Shares continued
Notice that the debit to Common shares in all three scenarios is

always based on the average issue price (total $ amount paid for
Common shares /number of common shares issued and outstanding) of
the shares repurchased. Should a loss arise, the amount should first
eliminate any Contributed Surplus in respect of that class of shares (i.e.,
amounts which arose from previous purchase transactions in that class
of shares) and then any remainder should be charged to Retained
Earnings. If there is no balance in Contributed Surplus, the amount is
charged directly to Retained Earnings.
Financial Statement Analysis
Earnings per share (EPS)
Calculation:
= Net income - preferred dividends/ Average number of common Shares

outstanding
This is a very important ratio often used by investors to gauge the

profitability of the company. Analysts watch EPS results very closely.

COMR 457
Financial Statement Analysis continued
Return on Shareholders’ Equity (ROE)
Calculation:
= Net Income - preferred dividends / Average common Shareholders’

Equity
Indicates the return common shareholders are earning on their

investment - the higher the return, the more attractive the company.
Price/Earnings ratio
Calculation:
= Current market price of a common share/ Earnings per share
Indicates whether the market price of the common shares is reasonable

in relation to the company’s earnings per share.
Dividend yield ratio
=Dividends per share/ Market price per share
Measures the dividends an investor will receive relative to the share

price.

Shareholders Equity

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COMR 457

Shares may be issued for cash, assets or services. Shares should be

© Scott M. Sinclair, FCPA, FCA 2022 1

When common shares are issued, the journal entry is:

The full amount for any consideration received is recorded in the

When an investor purchases shares of a company they may have many

© Scott M. Sinclair, FCPA, FCA 2022 2

There are three important dates with respect to dividends:

Date of Declaration – the date the dividend is declared by the

Date of Record – the date that the recipient of the dividend is

Date of Payment – the date the payment is actually made to the

Dr Dividends declared or Retained Earnings

Dividends declared is not an expense but rather a distribution of

© Scott M. Sinclair, FCPA, FCA 2022 3

On the date of record, no entry is necessary however the company now

On the payment date the journal entry is:

Stock (Share) Dividends

Although a company may have Retained Earnings (i.e., past earnings

© Scott M. Sinclair, FCPA, FCA 2022 4

Assume a company declares a 10% stock dividend. The journal entry on

Dr Stock dividends declared/Retained Earnings

The amount of the entry is determined as follows:

= Number of common shares currently outstanding * 0.10 *Current

Common shares issuable is not a liability as no assets of the company

Dr Common shares issuable

Notice that the effect of these two entries is:

Dr Stock dividends declared/Retained Earnings

© Scott M. Sinclair, FCPA, FCA 2022 5

© Scott M. Sinclair, FCPA, FCA 2022 6

Most preferred shares have a cumulative right for dividends. A

Occasionally a company may wish to repurchase its own common

In accounting for the acquisition and cancellation of a company’s own

The shares are repurchased for an amount that is equal to the

© Scott M. Sinclair, FCPA, FCA 2022 7

Repurchased Shares continued

Any gain or loss realized on the above noted transactions is

Shares purchased at average issue price:

Shares purchased at a price less than the average issue price:

Notice that any gain is credited to an account known as Contributed

Shares purchased at a price more than the average issue price:

© Scott M. Sinclair, FCPA, FCA 2022 8

Notice that the debit to Common shares in all three scenarios is

Financial Statement Analysis

Earnings per share (EPS)

= Net income - preferred dividends/ Average number of common Shares

This is a very important ratio often used by investors to gauge the

© Scott M. Sinclair, FCPA, FCA 2022 9

Return on Shareholders’ Equity (ROE)

= Net Income - preferred dividends / Average common Shareholders’

Indicates the return common shareholders are earning on their

= Current market price of a common share/ Earnings per share

Indicates whether the market price of the common shares is reasonable

Dividend yield ratio

=Dividends per share/ Market price per share

Measures the dividends an investor will receive relative to the share

© Scott M. Sinclair, FCPA, FCA 2022 10

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