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Paid-in Capital Fundamental Share Rights In reading the previous paragraphs, you noted that corporations raise equity funds by selling shares of the corporation. Shareholders are the owners of a corporation. If a corporation has only one class of shares, no designation of the shares is necessary, but they typically are labeled common shares. Ownership rights held by common shareholders, unless specifically ltheld by agreement with the shareholders, are as follows: Buiness Corporation Act, the American Bar Association, 201 ote on matters that come before the shareholders, includio directors. Each share represents one vote. Liabilities and Shareholders' Equity before the shareholders, including the SECTION 3 I. The right to vo percentage of shares owned by a shareholder determines hisvher share of dividends dis fa corporate in profits when dividends are declared. The 2. The right to share The percen The right to share in the distribution of assets if the company is liquit age of shares owned by a shareholder determines hiher sh and preferred shareholders are paid percentage share of ownership when new shares are issued. This ismaintai new Another right sometimes given to common shareholders is the right to Is referred to as tive right. Each shareholder is offered the opportunity to buy a percent states ssued equal to the percentage of shares he/she owns at the time. med unless contractuals must be specifically granted: in others, it is presu However, this right usually is not explicitly stated because of tx corporations when they issue new shares. The exclusion of the enience to be concerned about is inconsequential because few sharcholders own enough stock to he ownership percentage Distinguishing Classes of Shares classes of shares It is not uncommon for a firm to have more than one, and perhaps several, classesof each with different rights and limitations. To attract investors, companies have devised a variety of ownership securities If more than one class of shares is authorized by the articles of incorporatie specif rights of each (for instance, the right to vote, residual interest in assets, and di dividend rights) must be stated. Also, some designation must be given to distinguish each clas Some of the distinguishing designations often used are these: I. Class A, class B, and so on (Tyson Foods) 2. Preferred stock, common stock, and class B stock (Hershey's) 3. Common and preferred (HP) 4. Capital stock (Reader's Digest) 5. Common and serial preferred (Smucker's) mong share3. Commmon In your introductory study of accounting. you probably became most familiar common stock-preferred stock distinction. That terminology has deep roots in traditi Early English corporate charters provided for shares that were preferred over others as n rights. These provisions were reflected in early American corpo ration laws. But as our economy developed, corporations increasingly felt the need for inn f attracting investment capital. The result has been a gradual development f classifications that cannot easily be identified by these historica ther they mon or vative wide range of share designations To reflect the flexibility that now exists in the creation of equity shares, the Model Bus ness Corporation Act, and thus many state statutes, no longer mention the words comm and preferred. But the influence of tradition lingers. Most corporations still designate s common or preferred. For consistency with practice, the illustrations you stu chapter use those designations. As you consider the examples, keep in mind that the concepts apply regardless of the language used to distinguish shares. dy in thi san Typical Rights of Preferred Shares An issue of shares with certain preferences or features that distinguish shares customarily called common shares may be assigned any of tioned earlier. Very often the distinguishing designation is pre rights of preferred shareholders usually include one or both of the following 1. Preferred shareholders typically have a preference to a specified am it from the cl the several labels mer preferred shares. The special (stated dollar amount per share or % of par value per share). That is. ount of dividends if the board of CHAPTER 18 Shareholders' Equity 1045 ares dividends, preferred shareholders will receive the designated dividend dec vidends are paid to common shareholders. holders customarily have a preference (over common shareholders) as to ion of assets in the event the corporation is dissolved. dbhageholders sometimes have the right of conversion, which allows them to shaceertble Into ht Xerox Corporation had outstanding 300,000 shares of convertible pref preferred stock for common stock at a specified conversion ratio. For Shares may specified number of another class of ered ely. a redemption privilege might allow preferred shareholders the option, 2. Redeemoble af conditions, to return their shares for a predetermined redemption price. Pre icolders Each Xerox pr have preference over common stockholders in dividends and liqundatioe corporation option ot Shareholders eferred share is convertible into 90 common shares. Similarly, shares may at the option of the issuing corporation (sometimes referred to as callable) ered shares may be cumulative or noncumulative. Typically, preferred shares are e which means that if the specified dividend is not paid fe dvidends (called dividends in arrears) accumulate and must be made up in a later nd year before any dividends are paid on common shares. We see this illustrated in rticipating. A participating feature allows shareholders to receive additional dividends beyond the stated amount. If the pre ed shares are fully participating, the distribution of dividends to common and preferred wcholders is a pro rata allocation based on the relative par amounts of common and pre- igrd stock outstanding. Participating preferred stock, previously quite common, is rare today Remember that the designations of common and preferred imply no necessary rights, priv les, or limitations of the shares so designated. Such relative rights must be specified by h contract with shareholders. A corporation can create classes of preferred shares that are adiscinguishable from common shares in voting rights and/or the right to participate in assets Esributed as dividends or distributed upon liquidation). Likewise, it is possible to devise f common shares that possess preferential rights, superior to those of preferred shares Pecferred shares may be participatine s it Equity or Is It Debt? You probably also can imagine an issue of preferred shares that is almost indistinguishable The line between inm a bond issue. Let's say, for instance, that preferred shares call for annual cash divi- equity is hard to draw f 10% of the par value, dividends are cumulative, and the shares must be redeemed ir cash in 10 years. Although the declaration of dividends rests in the discretion of the ourd of directors, the contract with preferred shareholders can be worded in such a way that firectors are compelled to declare dividends each year the company is profitable. For a prof company, it would be difficult to draw the line between this issue of preferred shares a 10%, 10-year bond issue. Even in a more typical situation. preferred shares are some- table securities-a cross between equity and debt redeemable Mandatorily Sometimes the similarity to debt is even more obvious, Suppose shares are mandatorily edeemable- er that t -the company is obligated to buy back the shares at a specified future date. The shares are classified re makes this financial instrument tantamount to debt. A mandatorily redeem ncial instrument must be reported in the balance sheet as a liability, not as share dens equity. Extended Stay America, for instance, reported its mandatorily redeemable the company is obligated to pay cash (or other assets) at a fixed or determinable liabilities. cmed shares as a liability in its 2016 balance sheet. Concept of Par Value lier prevalent practice (besides labeling shares as common and preferred) that has little We have nf cance other than historical is assigning a par value to shares. The concept of par value archaic concept of par law. as far as the concept of owning shares of a business. Par value originally indi value from early corporate the real value of shares. All shares were issued at that price H Cenain Financial 150 (Norwalk, Co 0-254 Dinguishing Lisbilies from Equity-Overall Recoguitien (ervioesly Aocousting ement of Financial Accoanding Stindlands N of Both Liabilities and Equity"Sment 1046 SECTION 3 nternational Finrancial Hepdirilil Staloaru Distinction between Debt and Equity for Preferred Stock. Diffe and requirements can result in the same instrument being caserences debt and equity under IFRS and US. GAAP Under US. GAAR tytmported in the incom in uassified differenby beten stock L018-9is reported as equity, but is reported as debt with the ferredsensy preferred stock the critical feature that distinguishes a liability is if the issu Under cash (or another financial instrument) to the holder" Unilever deson be disclosure note: most non-mandatorily redeemabie preferred stock (preferene debt as well as some interest expense it st is mandatorily redeemable ement as shares that aren't redeemable. Urrepo Additional Information for U.S. Investors (in part) Preference Shares Under IAS 32, Unilever recognizes preference shares that dividend as borrowings with preference dividends recognized Under U.S. GAAP such preference shares are classified in scome e dividends treated as a deduction to shareholder's e a fixed preference reholders' equity with cases of selling shares for lss During the late 19th and early 20th centuries, many cases of selling ject of a number of lawsuits. Investors and creditors contended that value as the permanent investment in the corporation and therefled be at least that amount. Not only was par value assumed to be the holders, but it also was defined by early corporation laws as the available for distribution to shareholders (as dividends or otherwise par valuc-known as watered shares-received a great deal of attention hey relied on the net assets mus amount investod by shu Many companies began turning to par value shares with very low par values- Shares wilth nominal par value became common to nnies-to escape the watered shares liability of issuing shares below an pe dodge elaborate statutory value and to limit the restrictions on distributions. This practice is common today rules pertaining to par value shares. Accountants and attorneys have been aware for decades that laws pertaining to pe and legal capital not only are bewildering but fail in their intent to safeguard creditors payments to shareholders. Actually, to the extent that creditors are led to believe that are afforded protection, they are misled. Like the designations of common and prefem shares, the concepts of par value and legal capital have been eliminated entirely from Model Business Corporation Act." vae Many states already have adopted these provisions of the Model Act. But most esaite have par value shares continue The evolution will be gradual to the simpler, more meaningful provisions of the M orporations issued shares prior to changes in the state statutes. Consequently, most cmpui outstanding and continue to issue previously authorized par value shar del Ac In the meantime, accountants must be familiar with the outdated concepts of par vala st shares continue to arbiltrarily designated and legal capital in order to properly record and report transactions related to pu alues. shares. For that reason, most of the discussion in this chapter centers on par v Largely, this means only that proceeds from shareholders' investment is a stated capital and additional paid-in capital. Be aware, though, that in the absenc laws that prompted the creation of par value shares, there is no theoretical reason to of arhac Accounting for the Issuance of Shares Shares Issued For Cash When sha res are sold for cash (see Illustration 18-5), the capital stock accouni or preferred) is credited f to signated par value, that amount denotes stated capital and is cre L018-4 common have a or the amount representing stated cap tal. When American Bar Association, official comment to Section 6:21 of Shandard No. 32 (IASCF), as amended effective January

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