ACCT1006 s1 2021 Lecture Week 10 Lecturer COPY PDF

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ACCT1006: Accounting and Financial ManagementTimothy Ganghua WangWeek 10: Recording, Analysing, Managing and Reporting EquityFinancial AccountingIntroduction, GAAP & Business EntitiesStatement of Profit or LossStatement of Financial PositionStatement of Cash FlowsInternalControlInternalControlAc...

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ACCT1006: Accounting and Financial Management Week 10: Recording, Analysing, Managing and Reporting Equity Timothy Ganghua Wang

Introduction,GAAP&BusinessEntities AccountingConcepts&TransactionAnalysis

RecordingTransactions

Merchandising AccountingSubsystems Receivables Non‐currentAssets Liabilities Equity

Statementof ProfitorLoss Statementof Financial Position Statementof CashFlows

FinancialStatementAnalysis

InternalControl

FinancialAccounting

Not in student slides

What is Equity (Owners’ Equity)? – The residual interest (owners’ residual interest) in the assets of the entity after deducting all its liabilities

The University of Sydney

Page 3

Learning Objectives/Outcomes 1. 2. 3. 4. 5. 6. 7. 8. 9.

Identify main characteristics of a corporation. Record the issue of ordinary shares. Describe the effects of share splits. Prepare the entries for cash and share dividends. Understand the concept of earning power and indicate how irregular items are presented. Identify components of comprehensive income and changes in equity. Identify the items that affect retained earnings. Evaluate a company’s dividend and earnings performance from a shareholder’s perspective. Evaluate debt and equity as alternative sources of finance.

The University of Sydney

Page 4

Not in student slides

Learning Objectives/Outcomes 1. 2. 3. 4. 5. 6. 7. 8. 9.

Identify main characteristics of a corporation. Record the issue of ordinary shares. Describe the effects of share splits. Prepare the entries for cash and share dividends. Understand the concept of earning power and indicate how irregular items are presented. Identify components of comprehensive income and changes in equity. Identify the items that affect retained earnings. Evaluate a company’s dividend and earnings performance from a shareholder’s perspective. Evaluate debt and equity as alternative sources of finance.

The University of Sydney

Page 5

LO1 The Corporate Form of an 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

The University of Sydney

Page 6

Characteristics of a Company – Complete the list: – – – – – – –

Limited liability of shareholders Continuous life Subject to government regulations Ability to acquire capital Separate legal entity Transferable ownership rights Company controlled through elected board of directors

The University of Sydney

Page 7

Forming a Company – A company is formed by registration and bound by the Corporations Act 2001 – Each company is allocated an ACN (Australian Company Number) and can apply for an ABN (Australian Business Number) – 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 2001

The University of Sydney

Page 8

Ownership and Control – Separation of owners of a company (shareholders) to those who control it (directors) Advantage – Professional management run the business Disadvantage – Owners do not play an active role in the running of the business Role of accounting? – Owners require information to enable them to make decisions

The University of Sydney

Page 9

Corporations Act 2001 – The Corporations Act in – s286(1) states that a company must keep written financial records that: – correctly record and explain its transactions and financial position and performance, and – would enable true and fair financial statements to be prepared and audited – s295A: if the company is listed, directors must receive declarations from the CEO and CFO stating whether the financial report complies with accounting standards and the requirement to give a true and fair view – s296 states that the financial reports must comply with accounting standards The University of Sydney

Page 10

Shareholder Rights – Members (shareholders) have a right to the residual assets of the company – effectively the net assets – What if company is not a going concern – carrying amount of assets or liquidation value? – 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

The University of Sydney

Page 11

Shareholder Rights Rights Right to vote at annual general meetings Right to share in company’s profit

Ordinary shareholders

Preference shareholders

Yes

No

Yes, but don’t have priority over preference shareholders Right to a residual Yes, but don’t claim if company is have priority over liquidated preference shareholders The University of Sydney

Yes and have priority over ordinary shareholders Yes and have priority over ordinary shareholders Page 12

Not in student slides

Learning Objectives/Outcomes 1. 2. 3. 4. 5. 6. 7. 8. 9.

Identify main characteristics of a corporation. Record the issue of ordinary shares. Describe the effects of share splits. Prepare the entries for cash and share dividends. Understand the concept of earning power and indicate how irregular items are presented. Identify components of comprehensive income and changes in equity. Identify the items that affect retained earnings. Evaluate a company’s dividend and earnings performance from a shareholder’s perspective. Evaluate debt and equity as alternative sources of finance.

The University of Sydney

Page 13

LO2 Issue of Shares – Complete the list below: – A company normally receives cash in exchange for issuing shares – But can receive other assets or through a reduction in liabilities – When a company decides to issue shares, it must decide: – How many shares to issue? – At what price the shares should be issued? – How shares should be issued?

The University of Sydney

Page 14

Issue of Shares – Private placement involves issue of shares to certain private investors by invitation – Public issue requires a prospectus inviting public application for shares – The prospectus: – Reports on the company’s financial position, performance and plans – Contains reports from independent parties

The University of Sydney

Page 15

Issue of Shares – 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

The University of Sydney

Page 16

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 30 Sep Cash at Bank Share Capital (To record issue of 1000 shares at $1 each)

The University of Sydney

1 000 1 000

Page 17

Accounting for the Public Issue of Shares – Investors return the application form with appropriate application money for the number of shares they want – At times companies require full payment on application Application

– At other times companies only require part payment on application with the remainder due on allotment or subsequent calls on capital Application

Issue shares (allotment)

Amount payable on 1st call

Amount payable on 2nd call

– A call on capital is when a company asks shareholders to pay some or all of the unpaid capital on issued shares – When a public offering is handled by an underwriter – in this case these transactions would not be required

The University of Sydney

Page 18

Accounting for the Public Issue of Shares – 10,000 shares issued by instalment at $0.70, $0.50 due on application and $0.20 due on allotment Application money: 10,000 shares * $0.50 =$5,000 Section 722 of Corporations Act 2001, hold application money in trust Allotment money: 10,000 shares *$0.20 = $2000

19

30 Sep

Cash Trust (Asset)

5 000

Application (Liability)

5 000

(To record application for 10 000 shares) 1 Oct

Application (Liability)

5 000

Share Capital (Equity)

5 000

(To record issue of shares from application) 1 Oct

Cash at Bank (Asset)

5 000

Cash Trust (Asset) 1 Oct

(To record transfer of application money) Allotment (Receivable Asset)

5 000 2 000

Share Capital (Equity)

2 000

(To record issue of shares from allotment) 31 Oct

Cash at Bank (Asset)

2 000

Allotment (Receivable - Asset)

2 000

(To record receipt of monies from allotment) The University of Sydney

Note: differences in classification of accounts to text book: Application and Allotment

Page 20

Accounting for the Public Issue of Shares Assuming all the allotment received Date 1 Oct 1 Oct

Share Capital Dr Cr 5 000 2 000

Date 1 Oct 31 Oct

Allotment Dr Cr 2 000 2 000

Bal. 5 000 7 000

Bal. 2 000 0

Statement of Financial Position (Extract) as at 31 October Equity Fully paid share capital 7 000 The University of Sydney

Allotment is treated as “Asset” for J/E but it is treated as “Contra Equity” for Stmt of F/P

Assuming only partial allotment received Date 1 Oct 1 Oct

Share Capital Dr Cr 5 000 2 000

Bal. 5 000 7 000

Date 1 Oct 31 Oct

Allotment Dr Cr 2 000 1 200

Bal. 2 000 800

Statement of Financial Position (Extract) as at 31 October Equity Partially paid share capital 7 000 Less: Allotment 800 6 200 Page 21

Not in student slides

Learning Objectives/Outcomes 1. 2. 3. 4. 5. 6. 7. 8. 9.

Identify main characteristics of a corporation. Record the issue of ordinary shares. Describe the effects of share splits. Prepare the entries for cash and share dividends. Understand the concept of earning power and indicate how irregular items are presented. Identify components of comprehensive income and changes in equity. Identify the items that affect retained earnings. Evaluate a company’s dividend and earnings performance from a shareholder’s perspective. Evaluate debt and equity as alternative sources of finance.

The University of Sydney

Page 22

LO3 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

The University of Sydney

Page 23

Share Splits – 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 3 for 1 share split the market value of CSL shares fell from $100.80 to approximately $35 – No journal entry is required for a share split. Why? – An accountant records the monetary or financial effect of a transaction – under a share split there is no impact on the financial statements (share capital) of the company

The University of Sydney

Page 24

Not in student slides

Learning Objectives/Outcomes 1. 2. 3. 4. 5. 6. 7. 8. 9.

Identify main characteristics of a corporation. Record the issue of ordinary shares. Describe the effects of share splits. Prepare the entries for cash and share dividends. Understand the concept of earning power and indicate how irregular items are presented. Identify components of comprehensive income and changes in equity. Identify the items that affect retained earnings. Evaluate a company’s dividend and earnings performance from a shareholder’s perspective. Evaluate debt and equity as alternative sources of finance.

The University of Sydney

Page 25

LO4 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

The University of Sydney

Page 26

Cash Dividends – A cash dividend is a pro rata distribution of profit paid in cash to shareholders – A company must not pay a dividend unless: – (a) the company's assets exceed its liabilities immediately before the dividend is declared and the excess is sufficient for the payment of the dividend; and – (b) the payment of the dividend is fair and reasonable to the company's shareholders as a whole; and – (c) the payment of the dividend does not materially prejudice the company's ability to pay its creditors.

The University of Sydney

Page 27

Not in student slides

Cash Dividends – Closing entries for a company Entries at reporting date Step 1

Dr Revenue/Income accounts Cr Profit or loss summary

Step 2

Dr Profit or loss summary Cr Expense accounts

Step 3

Dr Profit or loss summary Cr Retained earnings

Step 4

Dr Retained earnings Cr Dividends declared

The University of Sydney

Page 28

Cash Dividends – Journal entry when dividend is declared ($0.50 per share on 100,000 shares) 1 Dec

Cash Dividends Declared/RE* Cash Dividends Payable

50 000 50 000

(To record declaration of cash dividend) * Retained earnings or Cash Dividends Declared

– YOUR TURN: Journal entry when dividend is paid 20 Dec Cash Dividends Payable Cash at Bank

50 000 50 000

(To record payment of cash dividend) The University of Sydney

Page 29

Cash Dividends – Closing Entries Assume 31 December is the end of financial year Option 1 – Using dividends declared ledger account 1 Dec

Cash Dividends Declared

50 000

Cash Dividends Payable 31 Dec Retained Earnings

50 000 50 000

Cash Dividends Declared

50 000

Option 2 – Using retained earnings ledger account 1 Dec

Retained Earnings Cash Dividends Payable

Easier

50 000 50 000

31 Dec No closing entry required to close Dividends Declared The University of Sydney

Page 30

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

The University of Sydney

Page 31

Share Dividends (50000*10%)$15=$75 000

– Journal entry when 10% share dividend on 50 000 shares. Current market value of share is $15 1 Jan

Retained Earnings*

75 000

Share Dividends Payable

75 000

(To record declaration of 10% share dividend) * Retained Earnings or Share Dividends Declared

– YOUR TURN: Journal entry when dividend is paid 20 Jan

Share Dividends Payable Share Capital

75 000 75 000

(To record issue of 5000, $15 shares as share dividend) The University of Sydney

Page 32

Not in student slides

Learning Objectives/Outcomes 1. 2. 3. 4. 5. 6. 7. 8. 9.

Identify main characteristics of a corporation. Record the issue of ordinary shares. Describe the effects of share splits. Prepare the entries for cash and share dividends. Understand the concept of earning power and indicate how irregular items are presented. Identify components of comprehensive income and changes in equity. Identify the items that affect retained earnings. Evaluate a company’s dividend and earnings performance from a shareholder’s perspective. Evaluate debt and equity as alternative sources of finance.

The University of Sydney

Page 33

LO5 Equity and Irregular Items – Retained earnings is the undistributed profits of a company – The earnings retained is affected by irregular items – (large) revenue or expenses that occur in only one accounting period – Removing the effect of the irregular items provides a clearer indication of future expected profits profit adjusted for irregular items is referred to as ‘earning power’

– Four types of irregular items are reported: i. Errors ii. Changes in accounting estimates iii. Changes in accounting policies iv. Discontinuing operations

The University of Sydney

Page 34

Equity and Irregular Items Errors – When an error in discovered in subsequent periods, the financial statements when the error occurred (not when it was discovered) must be retrospectively corrected – The correction of the error in revenues or expenses must not be reflected through the current periods Statement of Profit or Loss – In the period where the error was discovered disclosures must be provided on the 1. nature of the error 2. amount and financial statement line item(s) affected 3. restatement of all previous periods financial information The University of Sydney

Page 35

Equity and Irregular Items - Errors – In 2017 a $200,000 error was found where legal fees were recorded to land instead of expensed. – In 2016 Land overstated by $200,000 Expenses understated by $200,000 Profit overstated by $200,000 before the adjustment

2016 $000 2 500 (1 200) (100) 1 200 (360) 840 The University of Sydney

Page 36

2017

Retained Earnings Land

200 000 200 000

(To correct a prior period error)

It was 4 700 before the adjustment

The University of Sydney

Page 37

Equity and Irregular Items Changes in accounting estimates – When a change is made to an estimation method, the comparison between current and prior period is distorted. – The effect of the change must be disclosed as a note if material – Consider depreciation of $100,000 of equipment: – Prior year useful life estimated at 5 years – depreciation is $20,000 – Estimation changed to additional 10 years in current period – depreciation is $8,000 ($80,000/10) – The change in estimation will increase profit in the current period by $12,000 ($20,000-$8,000) The University of Sydney

Page 38

Equity and Irregular Items Changes in accounting policies – Financial statements are expected to be prepared consistent with the policies in the preceding period – Where choice under the accounting standards is allowed the initial policy should be maintained – Policies can change under: – required by accounting standard amendments – volunta...