Financial Accounting and Reporting

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 pre-emptive right protects an existing shareholder from involuntary dilution of ownership
interest.
The share system easily allows one individual to transfer an interest in a company to another
investor.
3. Development of a variety of ownership interests → In every corporation, one class of shares
must represent the basic ownership interest. That class of shares is called ordinary. Ordinary
shares represent the residual corporate interest that bears the ultimate risks of loss and receives
the benefits of success. By special contracts between the corporation and its shareholders,
however, the shareholder may sacrifice certain of these rights in return for other special rights or
privileges. Thus special classes of shares, usually called preference shares, are created. In return
for any special preference, the preference shareholder always sacrifices some of the inherent
rights of ordinary shareholders. A common type of preference is to give preference shareholders
a prior claim on earnings.
Equity is the residual interest in the assets of the company after deducting all liabilities. Equity is
often subclassified on the statement of financial position into the following categories: share
capital, share premium, retained earnings, accumulated other comprehensive income, treasury
shares and non-controlling interest (minority interest).
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 business. Earned capital is the capital that develops from profitable
operations. Retained earnings represents the earned capital of the company. Equity is a residual
interest and therefore its value is derived from the amount of the corporations’ assets and
liabilities.
The Share premium account indicates any excess over par value paid in by shareholders in return
for the shares issued to them. Once paid in, the excess over par becomes a part of the
corporation’s share premium.
Many countries permit the issuance of shares without par value, called no-par shares. The
reasons for issuance of no-par shares are twofold. First, issuance of no-par shares avoids the
contingent liability that might occur if the corporation issues par value shares at a discount.
Second, some confusion exists over the relationship between the par value and fair value. If
shares have no par value, the questionable treatment of using par value as a basis for fair value
never arises. A major disadvantage of no-par shares is that some countries levy a high tax on
these issues. Some countries require that no-par hares have a stated value. The stated value is a
minimum value below which a company cannot issue it.
A corporation issues two or more classes of securities for a single payment or lump sum, in the
acquisition of another company. The accounting problem in such 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 and (2) the incremental method.
Accounting for the issuance of shares for property or services involves an issue of valuation. The
general rule is companies should record shares issues 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.
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