Module09 PDF

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Module 9: Accounting for partnerships and corporations

Overview
In previous models, you studied accounting for sole proprietorships. In this module, you learn about partnerships and
corporations. Several important legal differences distinguish these three forms of business organizations, and each form has
significant advantages and disadvantages. Accountants provide services to all types of organizations, so you must understand
their unique characteristics.
For the most part, accounting for these three different types of business entities is the same. The asset and liability section of
the balance sheets are identical, as are the income statements.1 The differences are in how each type of business accounts
for the equity of its owners, known as owners equity for a sole proprietorship, partners equity for a partnership, and
shareholders equity for a corporation.
Test your knowledge
Begin your work on this module with a set of test-your-knowledge questions designed to help you gauge the depth of study
required.
Learning objectives
9.1 List the characteristics of a proprietorship and a partnership, and explain the importance of mutual
agency and unlimited liability in a partnership. (Level 2)
9.2 Allocate partnership earnings to partners (a) on a stated fractional basis, (b) in the partners capital
ratio, and (c) through the use of salary and interest allowances. (Level 1)
9.3 Explain the advantages, disadvantages, and organization of corporations. (Level 2)
9.4 Explain the differences in the financial statements for corporate and unincorporated organizations.
(Level 1)
9.5 Record the issuance of shares. (Level 1)
9.6 State the differences between common and preferred shares, and allocate dividends between
common and preferred shares. (Level 2)
9.7 Record cash dividends and explain their effects on the assets and shareholders equity of a
corporation. (Level 2)
9.8 Calculate book value per share and interpret and apply this ratio in decision-making scenarios.
(Level 2)
9.9 Record share dividends, share splits, and retirement of shares, and explain their effects on the
assets and shareholders equity. (Level 2)
9.10 Calculate earnings per share for companies with simple capital structures and interpret and apply
this ratio in decision-making scenarios. (Level 2)
9.11 Explain how the income effects of discontinued operations are reported. (Level 2)
9.12 Describe restrictions of retained earnings and accounting changes, and the disclosure of such items
in the financial statements. (Level 2)
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9.13 Explain the ethical issues around management incentive plans. (Level 1)
Module summary
Print this module
1 Corporations usually include a provision for income tax expense whereas proprietorships and partnerships
do not.
Assignment reminder
Assignment #3 is due this week (see Course Schedule). Please allocate time to complete and submit the
assignment by the deadline.
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Module 9 Test your knowledge
1. Total shareholders equity is $800,000. $100,000 of this total is 10,000 preferred shares. There are 100,000 common
shares authorized; 50,000 common shares issued, of which 48,000 shares are outstanding. What is the book value
per common share?
1. $14.00
2. $14.58
3. $16.00
4. $16.67
2. A corporations articles of incorporation establish the total number of shares that may be issued. What is the term
applied to these shares?
1. Outstanding shares
2. Issued shares
3. Common shares
4. Authorized shares
3. When a corporation issues common shares, what account are they credited to?
1. Current asset account

2. Intangible asset account
3. Long-term investment account
4. Equity account
4. What are shares that carry voting rights called?
1. Preferred shares
2. Voting shares
3. Common shares
4. Contributed capital
5. The retained earnings account had a debit balance of $3,000 at the beginning of 2010. During 2010, net income
totalled $12,000 and dividends of $8,000 were paid. During 2011, no dividends were paid and an economic slowdown
caused the business to lose $25,000. What was the balance of the retained earnings account at the end of 2011?
1. $18,000
2. $18,000 deficit
3. $24,000
4. $24,000 deficit
Solutions
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9.1 Characteristics of proprietorships and partnerships
Learning objective
List the characteristics of a proprietorship and a partnership, and explain the importance of mutual agency and unlimited
liability in a partnership. (Level 2)
Required reading
Chapter 14, pages 694-699
LEVEL 2
Proprietorship
A proprietorship is a business owned by one person, while a partnership is an association of two or more persons to
operate an unincorporated business for profit as co-owners. From an accounting perspective,
proprietorships and partnerships must comply with the business entity
principle that requires that business records must be kept separate and distinct from owners
personal records. From a legal perspective, proprietorships and partnerships are extensions of their owners.
Neither the proprietorship nor the partnership is subject to income taxes; rather, the individuals are required to report their
share of income from these businesses on their respective tax returns.
Advantages and disadvantages of a proprietorship
The primary advantage of a proprietorship is the ease with which it can be legally started with only a limited number of legal
filing requirements. As stated above, a proprietor is required to keep adequate records for determining income, which is then
taxable in the hands of the proprietor. The advantage of ease of ownership is counteracted by disadvantages that include the
following:
Limited life: Upon the death of the proprietor, the business entity ceases.
Unlimited liability: The proprietor is liable for all debts of the proprietorship to the full extent of his or her personal
wealth.
Difficulty of ownership transfer: Selling the business to another party may be more difficult than selling a
corporation.
Partnership
Individuals entering into a business partnership should seek accounting and legal advice before they start a business. CGAs in
public practice often provide their expertise to a new partnership by advising on financial and tax matters and reviewing the
partnership contract to ensure that it addresses unforeseen events. The partners should enter into a partnership agreement
that sets out the terms under which the affairs of the partnership will be conducted. This document should be prepared by
their legal counsel.
The text describes the characteristics of general partnerships on pages 695-697.
Textbook activities
Checkpoint Questions 1 and 2 on

page 697 (Solutions on page 717)
Quick Study 14-1 and 14-2 on page 721

(Solutions)
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Accounting for a partnership and sole proprietorship is basically the same, except for transactions that directly affect partners
equity. There is no distinction between contributed and earned capital when accounting for partnerships and proprietorships
because the categories are combined. Proprietorships employ one capital account and one withdrawals account. The capital
account is credited for owner investments and accumulated profits. The withdrawals account is closed to the capital account
at the end of each accounting period.
Accounting for partnerships is explained on page 698 of the text.
Textbook activities
Checkpoint Question 3 on page 699

(Solution on page 717)
Quick Study 14-3 on page 721 (Solution)

9.2 Division of partnership earnings
Learning objective
Allocate partnership earnings to partners (a) on a stated fractional basis, (b) in the partners capital ratio, and (c) through the
use of salary and interest allowances. (Level 1)
Required reading
LEVEL 1
Nature of partnership earnings
Profits and losses arising from the operation of a business may be shared in any manner that the partners agree on.
Typically, the partnership agreement stipulates how profit/losses are to be shared. The basis for profit/loss sharing is usually
based on a formula that takes into consideration the time and money each partner invests in a partnership. The profit sharing
may include a salary allowance; the allowance is a distribution of earnings, not an expense.
Accounting for the division of income is explained on pages 699-703 of the text.
Textbook activities
Checkpoint Questions 4 to 6 on
Quick Study 14-4, 14-5, and 14-6 on
page 721 (Solutions)
Mid-Chapter Demonstration
Problem on pages 705-707
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9.3 Corporate organization
Learning objective
Explain the advantages, disadvantages, and organization of corporations. (Level 2)
Required reading
LEVEL 2
A corporation is a legal entity incorporated under federal or provincial laws such as the Canada
Business Corporations Act (CBCA) or the
Business Corporations Act of a particular province. The
characteristics of the corporate form and the process for organizing a company are described on pages 734-739.
Textbook activities


(Solutions)

9.4 Corporate financial statements
Learning objective
Explain the differences in the financial statements for corporate and unincorporated organizations. (Level 1)
Required reading
Note: Delete section titled Statement of Retained Earnings on page 740 and replace with the reading titled Statement of
Changes in Equity below.
LEVEL 1
Income statement
The basic difference between the income statement of a corporation and that of an unincorporated business is the inclusion
of income tax expense, as highlighted in Exhibit 15.3 on page 739. Also, if the owner works for the corporation and is paid a
salary, then the amount earned would be expensed, not charged to the proprietor or partners capital account.
Statement of comprehensive income (non-examinable)
Entities are required to report comprehensive income. This requirement primarily applies to companies with complex financial
arrangements. Comprehensive net income is the total of net income and other comprehensive income. Other comprehensive
income includes items not covered in this course, such as unrealized gains and losses on translation of financial statements of
self-sustaining foreign operations, unrealized gains and losses on foreign currency hedges, and unrealized gains and losses
on financial assets that are available for sale. The starting point for the computation of comprehensive income is net income
computed in the same manner as before. This statement is non-examinable.
Statement of changes in equity

7 FRS 2009, IAS 1 , para. 10 and para. 106-110
Source: Larson and Jensen, Fundamental Accounting

Principles , 13th Canadian edition ( 2010 McGraw-Hill Ryerson), Exhibit 13.6, page 742.
Reproduced with permission.
Balance sheet
The equity section on the balance sheet is called Owners Equity and Partners Equity for sole proprietorships and
partnerships respectively. For corporations, the equity section is labelled Shareholders Equity or simply Equity. As explained
above, the types of activities summarized in the equity section are identical regardless of the type of business organization
owner investment, net income and losses, and distribution of net income (withdrawals or dividends). Refer to Exhibit 15.5 on
page 741, which contrasts the balance sheet of a sole proprietorship with that of a corporation.
On the corporate balance sheet, shareholders equity is composed of two main categories: contributed capital and retained
earnings.
Contributed capital is the portion of a corporations equity that represents investments in the company by its
shareholders.

Retained earnings is the portion of a corporations equity that represents its cumulative net income less
net losses and dividends.
LEVEL 2
Contributed surplus
Contributed surplus is a third category (see page 794 in Chapter 16). The text uses the term contributed capital from
retirement of common shares. Contributed surplus from retirement of common shares is an alternate term with the same
meaning. This category will be explained in more detail in Topic 9.9.
Accumulated other comprehensive income (non-examinable)
Accumulated other comprehensive income is a fourth category in shareholders equity. Accounting for accumulated other
comprehensive income is beyond the scope of this
course and is covered in FA3 . This category is non-examinable.
Textbook activities
Checkpoint Questions 2, 3, and 5 on

page 741 (Solutions on pages 756-757)
Quick Study 15-3 to 15-7 on pages 764-
765 (Solutions)

9.5 Issuance of shares
Learning objective
Record the issuance of shares. (Level 1)
Required reading
LEVEL 1
Sale of shares
A company acquires assets to earn profits for the owners. These assets are collectively paid for with a combination of debt
and equity. The primary reason that a company sells shares is to raise money to invest in assets. Sometimes, however, a
company uses the proceeds to pay down debt. Shares can be issued for cash, other noncash assets, or services. Selling
shares for cash is the norm.
Authorized, issued, and outstanding shares
A corporation normally authorizes the distribution of an unlimited number of shares. However, a company may choose to
place a limit on the number of shares it issues, including this maximum in its articles of incorporation. Some provincial
jurisdictions require that the corporate charter authorize the maximum number of shares that may be issued, rather than
allowing for an unlimited amount.
Make sure you can differentiate between the terms authorized, issued, and outstanding:
Authorized refers to the number of shares a corporation is permitted to issue.
Issued refers to the number of shares sold that have not yet been cancelled.
Outstanding refers to the number of shares that have been issued and are still held by shareholders.1
Exercise 15-1 on page 768 compares the entries between a partnership and a corporation.
Solution
Note that there are important differences in the types of accounts used for a partnership and a corporation. For a
partnership, any cash distribution is made through the partners withdrawal accounts, whereas a cash distribution from a
corporation uses a dividend account. Observe that the Income summary account for a partnership is closed to the partners
Capital accounts, while the Income summary account for a corporation is closed to the Retained earnings account. (Closing
entries for a corporation is covered in Topic 9.7.) Also note in the previous exercise that for both a partnership and a
corporation, a credit of $96,000 would have been recorded in the Income summary account when the revenue and expense
accounts were closed for the year. (See Topic 3.5 for a review of closing entries.)
Textbook activities
Checkpoint questions 6 and 7 on


(Solutions)

1 The number of issued and outstanding shares will usually be the same. The only time they differ is when
the firm holds treasury shares, described in Appendix 16A, pages 811-813. This is infrequent, as treasury
shares are no longer allowed by the CBCA. The topic of treasury shares is beyond the scope of this
course and is non-examinable.

9.6 Classes of shares and special features of preferred shares
Learning objective
State the differences between common and preferred shares, and allocate dividends between common and preferred shares.
(Level 2)
Required reading
Chapter 15, pages 744-747 and 750-754
LEVEL 2
The Canada Business Corporations Act

(CBCA) does not distinguish between common and preferred shares. The Act, however, does allow for more than one class of
shares. Because of the predominant usage of the terms common and preferred to distinguish classes of shares, this
terminology is used throughout the text and these module notes.
Common shares
Common shares are known as the residual class because common shareholders claims to assets and profits of a business
rank behind those of creditors and preferred shareholders. The five basic rights of the common shareholder are summarized
in Exhibit 15.10 on page 746.
Preferred shares
A company may issue nonvoting shares,known as preferred shares.1 Preferred shares differ from common shares in terms
of the rights and privileges related to dividends, liquidation, and conversion. Preferred shares usually include a preference for
payment of dividends and for distribution of assets in liquidation. The dividend preference simply means that preferred
shareholders are entitled to dividends before common shareholders.
Preferred dividends are generally limited to a fixed amount and must be paid to preferred shareholders before common
shareholders receive dividends. Preferred shareholders are usually less concerned with growth in the future earning potential
of the company than common shareholders because preferred dividends are generally fixed in amount and do not vary with
earnings. The equity section on the balance sheet or accompanying notes discloses the dividend as a stated amount per
share or as a percentage of the issue price. Refer to Exhibit 15.8 on page 745, where the dividend preference per preferred
share is $3.
Study the format of the shareholders equity section of the balance sheet presented in Exhibit 15.8. Note that it is classified
and shows preferred shares and common shares under the heading Contributed capital.
Special features of preferred shares
Much like bonds, preferred shares are governed by an agreement between the corporation and investor. This contract can
make provision for any number of terms; some of the more common ones are described on pages 750-754.
Textbook activities

Judgement Call on page 747 (Solution on page 756)

Problem on pages 747-748.
Remember to record the issuance of shares that are exchanged for noncash assets and services.
1 Preferred shares sometimes have voting privileges, usually in narrowly defined circumstances such as
default under the terms of the preferred indenture. This footnote regarding preferred shares is provided
for information only and is non-examinable.

9.7 Cash dividends and closing entries for a corporation
Learning objective
Record cash dividends and explain their effects on the assets and shareholders equity of a corporation. (Level 2)
Required reading
Chapter 15, pages 749-750 and 754-755
LEVEL 2
Cash dividends
Determining when a company should pay a dividend and how much it should pay is beyond the
scope of this course . A corporation faces two practical considerations when
considering paying a dividend:
1. Is it legally permitted to pay a dividend?
Most provinces prohibit the paying of cash dividends unless a corporation has a sufficient credit balance in its retained
earnings account. For corporations incorporated under the Canada Business
Corporations Act , a corporation is not permitted to declare or pay dividends
if
a. The corporation is, or would after the payment be, unable to pay its liabilities as they become due, or
b. The realizable value of the corporations assets would thereby be less than the aggregate of its liabilities and
stated capital of all classes.
2. Does it have the money to pay the dividend?
A company may have sufficient retained earnings but little or no available cash. Recall that retained earnings are a
component of shareholders equity that reflects retained profitability. It is entirely possible to have a large balance in
this account, but little cash, because the company reinvested its profits in other assets such as inventory and
equipment.
A company is not obligated to declare dividends. The decision to declare dividends is the board of directors responsibility.
Once a cash dividend has been declared, however, it becomes a binding obligation, and, as such, it is necessary to record a
liability. The manner in which this obligation is recognized is set out on page 749. Note that on the declaration date,
Dividends declared (a temporary contra equity account) is debited and Dividends payable (a current liability account) is
credited.1 Alternatively, Retained earnings may be debited directly instead of Dividends declared.
Closing entries for a corporation
The closing entries for a corporation are based on the same principles as for a sole proprietorship and partnership. The
difference is into which account the income summary and the distribution of income (either as withdrawals or as dividends)
are closed. The closing process for a sole proprietorship and a corporation are contrasted in Example 9-1.
Textbook activities
page 752 and question 14 on page 755
(Solutions on page 757)

767 ( Note: For Quick Study 15-14 to 15-

16, in part b for each, replace
Prepare a statement of retained
earnings with Prepare a
statement of changes in equity . The part
b solutions for each of Quick Study 15-14 to 15-16 are shown below)
Demonstration Problem on pages 757-

759 (NOTE: Replace part 2 of the required with Prepare statements of changes in equity for the years ended
December 31, 2011 and 2012. The revised solution to part 2 is shown below).
Review the Required and Planning the Solution closely before attempting the question. Ingraining this process of
determining what is required and how to approach the problem through repetition will serve you well when you write
your final examination.
Part b solutions to Quick Study 15-14 to 15-16:
Quick Study 15-14, Part b solution:
PETER PUCK INC.

Statement of Changes in Equity
For Year Ended May 31, 2011
Preferred Common Retained
Shares Shares Earnings Total Equity
Balance, June 1 $ 7,000 $ 13,000 $ 29,000 $ 49,000
Issuance of shares -0- -0- -0-
Net income (loss) 34,000 34,000
Dividends (3,500) (3,500)
Balance, May 31 $ 7,000 $ 13,000 $ 59,500 $ 79,500
NOTE: Because no shares were issued during the year ended May 31, 2011, the Issuance of shares line in the Statement
of Changes in Equity could be omitted.
MORRIS INC.
For Year Ended November 30, 2011
Common Retained
Preferred Shares Shares Earnings Total Equity
Balance, December 1 $ 10,000 $ 48,000 $ 42,000 $ 100,000
Net income (loss) (9,000) (9,000)
Dividends (14,000) (14,000)
Balance, November 30 $ 10,000 $ 48,000 $ 19,000 $ 77,000
NOTE: Because no shares were issued during the year ended November 30, 2011, the Issuance of shares line in the
Statement of Changes in Equity could be omitted.
VELOR LTD.
For Year Ended August 31, 2011
Preferred Common
Shares Shares Retained Earnings/(Deficit) Total Equity
Balance, September 1 $ 10,000 $ 48,000 $ 12,000 $ 70,000
Net income (loss) (18,000) (18,000)
Dividends -0- -0-
Balance, August 31 $ 10,000 $ 48,000 $ (6,000) $ 52,000

NOTE: Because no shares were issued and no dividends were declared during the year ended August 31, 2011, the
Issuance of shares and Dividends lines in the Statement of Changes in Equity could be omitted.
Part 2 solution to Demonstration Problem:
1 The text uses the terminology cash dividends rather than dividends declared.

9.8 Book value per share
Learning objective
Calculate book value per share and interpret and apply this ratio in decision-making scenarios. (Level 2)
Required reading
Appendix 15A, pages 760-761
LEVEL 2
Book value per share measures shareholders equity on a per share basis and represents the worth of each share if the
company were to be liquidated, based on balance sheet values. As balance sheet amounts are based on cost and not current
values, the book value per share provides little practical information.
Note:
Appendix 15A on pages 760-761 demonstrates how book value per share is calculated. Pay particular attention to Exhibit
15A.4 on page 761, where cumulative dividends in arrears are deducted from common shareholder equity to determine the
book value per share.
Textbook activities
Judgement Call on page 762 (Solution on page 762)


9.9 Additional share transactions
Learning objective
Record share dividends, share splits, and retirement of shares, and explain their effects on the assets and shareholders
equity. (Level 2)
Required reading
LEVEL 2
Share dividends
Paying cash dividends requires cash that the company may not have. A company with good investment opportunities may
prefer to reinvest its cash assets in future expansion projects. Therefore, a company may decide to distribute a dividend in
the form of shares. This is known as a share dividend (or stock dividend ); it increases the number of shares
outstanding. Accounting for this form of dividend is illustrated on pages 789-791.
Exercise 16-1 on page 817 shows the effect of a share dividend on contributed capital and retained earnings. Notice that the
total amount of shareholders equity does not change.
Solution
Share splits
A share split (or stock split ) occurs when a company issues more than one new share for each share previously
outstanding. In a two-for-one split, each existing shareholder would own twice as many shares as before the split. However,
because all shareholders receive a proportionate increase, their percentage ownership remains the same.
Accounting for share splits is explained on page 792.
Exercise 16-2 on page 817 shows the effect of a share split on shareholders equity. In particular, notice the effect the share
split has on the amount of shares outstanding.
Solution
Textbook activities

(Solutions)
Repurchase of shares
Companies frequently buy back their own shares and retire them. Why? Perhaps a company has surplus cash and sees its
own stock as the best investment it can make, or it may want to improve earnings per share (EPS). Whatever the reason,
when a company repurchases its own shares for immediate retirement, all capital items related to the shares are removed
from the accounts. The difference between the average price the shares were sold for, and the price paid to re-acquire them,

results in a gain or a loss. This gain or loss flows directly to equity it is never recorded on the income statement.
Accounting for the redemption (or repurchase) of shares is outlined on pages 793-794.
Textbook activities


(Solutions)
Problem on pages 795-797

9.10 Earnings per share
Learning objective
Calculate earnings per share for companies with simple capital structures and interpret and apply this ratio in decision-making
scenarios. (Level 2)
Required reading
Chapter 16, pages 797-800 (Note: The section titled Earnings Per Share and Extraordinary Items on pages 801-802 and all
subsequent references to extraordinary items have been omitted. Extraordinary items are not recognized under IFRS).
LEVEL 2
The earnings per share (EPS) figure conveys how much of a company's earnings "belong" to each outstanding common
share. Earnings that "belong" to or are available to common shareholders is net income for the year less the
amount that must be paid to preferred shareholders for the current year.
EPS is a widely followed and quoted financial performance statistic that public companies report on their income statement.
Companies with simple capital structures
The outstanding share capital of companies with a simple capital

structure consists solely of common shares, or common and non-convertible preferred shares. Public
companies with a simple capital structure report basic EPS. The computation of basic EPS is outlined on pages 797-800.
Public companies with capital structures that are not simple (known as complex capital structures) will be covered in FA3 .
Textbook activities
Checkpoint Questions 5, 6, and 7 on


816 (Solutions)

9.11 Reporting income
Learning objective
Explain how the income effects of discontinued operations are reported. (Level 2)
Required reading
The following reading replaces pages 802-804 of Chapter 16 in the textbook.
LEVEL 2



Principles , 13th Canadian edition ( 2010 McGraw-Hill Ryerson), pages 799-801. Reproduced with
permission.

9.12 Retained earnings
Learning objective
Describe restrictions of retained earnings and accounting changes, and the disclosure of such items in the financial
statements. (Level 2)
Required reading
The following reading replaces pages 805-807 of Chapter 16 in the textbook.
LEVEL 2




permission.
Reinforcement activities
Question 1
Answer the questions about each of the following items related to a company's activities for the year:
1. After using an expected useful life of seven years and no residual value to depreciate its office equipment over the
preceding three years, the company decided early this year that the equipment would last only two more years. How
should the effects of this decision be reported in the current financial statements?
2. An account receivable in the amount of $180,000 was written off two years ago. It was recovered this year. The
president believes this should be reported as an error. How should the proceeds be reported in the current year's
financial statements?

Principles , 13th Canadian edition ( 2010 McGraw-Hill Ryerson), page 813. Reproduced with
permission.
Solution:
1. This change in the predicted useful life is a change in an accounting estimate. The current year depreciation should
be modified to reflect the change and be reported on the income statement as part of income from continuing
operations.
2. This is not an error. It should be treated as a normal recovery of an account previously written off. Therefore, it does
not impact the current income statement or prior retained earnings. The recovery affects only balance sheet accounts.
Source: Larson and Jensen, Solutions Manual to

Fundamental Accounting Principles , 13th

Canadian edition ( 2010 McGraw-Hill Ryerson), page 250. Reproduced with permission.
Question 2:
Barton Inc. changed the method of calculating depreciation on its equipment from straight-line to double-declining-balance
during 2011. The cumulative effect of the change is an additional expense of $46,000 related to prior years. The tax benefit
is $13,000. Record the entry on December 31, 2011.

Principles , 13th Canadian edition ( 2010 McGraw-Hill Ryerson), page 813. Reproduced with
permission.
Solution:
2011
Dec. 31 Retained Earnings 33,000
Income Tax Payable 13,000
Accumulated Depreciation, Equipment 46,000
To record change in method of calculating depreciation.
Replace the Demonstration Problem

on pages 809-810 with the following:




permission.

9.13 Ethics Insider trading
Learning objective
Explain the ethical issues around management incentive plans. (Level 1)
Required reading
ERH , Unit A8, Making moral choices good enough for real-life circumstances
LEVEL 1
Throughout this course, full-disclosure and fairness in reporting have been emphasized. Accountants have a responsibility to
ensure that financial reports are designed not to deceive stakeholders. Consider the following case. Then refer to ERH ,
Unit A8, to apply a method of thinking through ethical choices when analyzing this case.
Falcon Corporations board of directors and officers have been meeting to discuss and plan the agenda for the corporations
2008 annual shareholders meeting. The first item considered by the directors and officers was whether to report a large
government contract that Falcon has just obtained. Although this contract will significantly increase income and cash flows in
2008 and beyond, management decided that there is no need to reveal the news at the shareholders meeting. After all,
one officer said, the meeting is intended to be the forum for describing the past years activities, not the plans for the next
year.
After concluding that the contract will not be mentioned, the group moved on to the next topic for the shareholders meeting.
This topic is a motion for the shareholders to approve a compensation plan that will award the managers the rights to acquire
large quantities of shares over the next several years. According to the plan, the managers will have a three-year option to
buy shares at a fixed price that equals the market value of the shares as measured 30 days after the upcoming shareholders
meeting. In other words, the managers will be able to buy shares in 2009, 2010, or 2011 by paying the 2008 market value.
Obviously, if the shares increase in value over the next several years, the managers will realize large profits without having to
invest any cash. The financial vice-president asks the group whether they should reconsider the decision about the
government contract in light of its possible relevance to the vote on the share option plan.
Identify the legal and ethical issues involved in this case. Then click on the link for an in-depth analysis.

file:////cgafs2/VOL1/Courses/2010-11/CGA/FA1/06course/m09summary.htm
Module 9 summary
Accounting for partnerships and corporations
List the characteristics of a proprietorship and a partnership, and explain the importance
of mutual agency and unlimited liability in a partnership.
A sole proprietorship has one owner.
A partnership is an association between the partners (two or more owners) to operate a business for profit.
All partners in a general partnership are personally liable for all the debts of the partnership.
The risk of becoming a partner results in part from the fact that partnership characteristics include mutual agency
and unlimited liability.
Mutual agency means that you are responsible for your partners actions.
The partners are jointly and severally liable for all debts incurred by the partnership. Each of the partners has
unlimited liability.
Allocate partnership earnings to partners (a) on a stated fractional basis, (b) in the
partners capital ratio, and (c) through the use of salary and interest allowances.
A partnerships net income or losses are allocated to the partners according to the partnership agreement.
The agreement may specify that each partner will receive a given fraction, or that the allocation of income and losses
will reflect salary allowances and/or interest allowances.
When salary and/or interest allowances are granted, the residual net income or loss is usually allocated equally or on
a stated fractional basis.
Explain the advantages, disadvantages, and organization of corporations.
Advantages of the corporate form of business include

separate legal entity
limited liability
continuity
no mutual agency
Disadvantages include
strict government regulations
corporations are subject to various taxes that other business entities are not, including income taxes
Explain the differences in the financial statements for corporate and unincorporated
organizations.
The equity section on the balance sheet is called owners equity and partners' equity for sole proprietorships and
partnerships respectively. For corporations, the equity section is labelled shareholders equity.
Shareholders equity consists of

contributed capital
retained earnings
Record the issuance of shares.
When shares are issued, the proceeds are credited to a share capital account which forms part of contributed capital.
State the differences between common and preferred shares, and allocate dividends
between common and preferred shares.
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The Canada Business Corporations

Act (CBCA) allows for more than one class of shares.
Common shares are known as the residual class because common shareholders claims to assets and profits of a
business rank behind those of creditors and preferred shareholders.
Preferred shares differ from common shares in terms of the rights and privileges related to dividends, liquidation, and
conversion.
Preferred dividends are generally limited to a fixed amount and must be paid to preferred shareholders before
common shareholders receive dividends.
Record cash dividends and explain their effects on the assets and shareholders equity of
a corporation.
A company is not obligated to declare dividends. The decision to declare dividends rests with the board of directors.
Once a cash dividend has been declared, it becomes a legal obligation and a liability must be established.
Cash dividends transfer corporate assets to the shareholders, reducing a companys assets and equity.
Calculate book value per share and interpret and apply this ratio in decision-making
scenarios.
Book value per share measures shareholders equity on a per share basis based on balance sheet values.
As balance sheet amounts are based on cost as opposed to current values, the book value per share provides little
practical information.
Record share dividends, share splits, and retirement of shares, and explain their effects
on the assets and shareholders equity.
A share dividend occurs when a company makes a pro rata distribution of additional common shares to existing
shareholders.
A share split occurs when a company issues more than one new share for each share previously outstanding.
For both share dividends and share splits, because all shareholders receive the same proportionate increase in
shares, their percentile ownership of the company remains unchanged.
Neither a share dividend nor a share split affect assets or total shareholder equity.
Share dividends transfer monies from retained earnings to share capital.
When a company repurchases its own shares for immediate retirement, all capital items related to the shares are
removed from the accounts. The gain or loss flows directly to equity.
Calculate earnings per share for companies with simple capital structures and interpret
and apply this ratio in decision-making scenarios.
Earnings per share (EPS) conveys how much of a companys earnings "belong" to each outstanding common share.
Earnings that "belong" to or are available to common shareholders is net income for the year less the
amount that must be paid to preferred shareholders for the current year.
EPS is calculated by dividing net income less dividends to preferred shares by the weighted-average number of
common shares outstanding.
Explain how the income effects of discontinued operations are reported.
Discontinued operations are the operations of a business segment that has been sold, abandoned, shut down, or
otherwise disposed of, or that is the subject of a formal plan of disposal.

The net income or loss from operating the segment and the gain or loss on disposal are separately reported
on the income statement below income from continuing operations and are reported net of tax.
Describe restrictions of retained earnings and accounting changes, and the disclosure of
such items in the financial statements.
Retained earnings can be restricted so as to inform shareholders that the full amount of retained earnings is not
available for distribution by way of dividends.
Restrictions are disclosed in the notes to the financial statements.
Accounting changes include:
changes in accounting policy or principle, which require retroactive restatement of financial statements
A change in accounting policy occurs when an entity adopts a policy different from the one previously used.
In order for users of the financial statements to understand the effects of a change in accounting policy:
previous years results must normally be restated, and
the nature and justification for the change must be disclosed
correction of errors in prior financial statements, which requires restatement of the prior years financial
statements, but has no effect on the current years operating results
change in estimate, which is accounted for in period of change and future
Explain the ethical issues around management incentive plans.
Management may desire to prepare misleading financial reports to ensure that they receive performance-based
bonuses.
Accountants have a responsibility to ensure that financial reports are designed not to deceive stakeholders.

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Module 9 Test your knowledge solutions
a.
1. Incorrect. ($800,000 $100,000) 50,000 = $14.00; however, the denominator is supposed to be based on the
number of common shares outstanding (48,000) and not the number of common shares issued.
2. Correct. The book value per common share is $14.58, calculated as $800,000 $100,000 = $700,000 48,000
outstanding common shares = $14.58.
3. Incorrect. $800,000 50,000 = $16.00; however, the $100,000 contributed capital belonging to the preferred
shareholders was not subtracted in the numerator. Also the denominator should be based on the number of common
shares outstanding (48,000) and not the number of common shares issued.
4. Incorrect. $800,000 48,000 = $16.67; however, the $100,000 contributed capital belonging to the preferred
shareholders was not subtracted in the numerator.
b.
1. Incorrect. Outstanding shares are shares that have been issued and are actually held by shareholders.
2. Incorrect. Issued shares are shares that have been sold.
3. Incorrect. Common shares have voting rights and are held by the residual owners of a corporation.
4. Correct. Authorized shares is the term applied to the total number of shares that may be issued as established by
the corporations articles of incorporation.
c.
1. Incorrect. Common shares issued by a corporation are not recorded by that corporation as current assets.
2. Incorrect. Common shares issued by a corporation are not recorded by that corporation as intangible assets.
3. Incorrect. Common shares issued by a corporation are not recorded by that corporation as part of a long-term
investment account.
4. Correct. Common shares issued by a corporation are recorded by that corporation as an equity account.
d.
1. Incorrect. Preferred shares do not have voting rights.

2. Incorrect. Voting shares is not the term normally used to describe shares with voting rights.
3. Correct. Common shares have voting rights.
4. Incorrect. Contributed capital is a category in Shareholders equity on a corporate balance sheet.
e.
1. Incorrect. The balance was a deficit rather than a credit balance.

2. Incorrect. $3,000 + $12,000 $8,000 $25,000 = ($18,000) deficit. However, the $3,000 beginning balance should
be subtracted and not added because it is a debit balance.
3. Incorrect. The balance was a deficit rather than a credit balance.
4. Correct. The balance of the Retained earnings account at the end of 2011 was a $24,000 deficit, calculated as
$3,000 + $12,000 $8,000 $25,000 = $24,000.
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file:////cgafs2/VOL1/Courses/2010-11/CGA/FA1/06course/m09t05sol.htm
Exercise 15-1 solution
a. Suppose Tom and Joans company is organized as a partnership, the following entries would be prepared to record
the business start-up and its operations:
b. Suppose the company is organized as a corporation that issued 1,000 common shares, the following entries would
record the business start-up:
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3.5 Closing entries
Learning objective
Prepare closing entries for a service business. (Level 1)
Required reading
LEVEL 1
Accounts are either permanent or temporary in nature. Balance sheet accounts are permanent accounts, while income
statement accounts are temporary.
Permanent accounts are continuous accounts their balances are carried forward from one
accounting period to the next. Using cash as an example, the cash account balance fluctuates during the accounting period
as deposits and payments are made. The ending cash balance from one period becomes the beginning cash balance for the
next period; therefore, the account continues from one period to the next.
Temporary accounts are periodic accounts , and at the end of each accounting
period, their balances are closed (transferred) to owners equity. The revenue account, for example, is a
temporary account. The revenue account for each accounting period begins with a zero balance.
Closing entries transfer the balances in the temporary accounts (revenue, expense, and withdrawals accounts) to a balance
sheet equity account (owners capital for a sole proprietorship). The closing process is described and illustrated on pages 196-
201. Work through the example in Exhibits 5.10 to 5.13 and check your understanding of the subject.
Textbook activity

Quick Study 5-5 to 5-7 on pages 220-221
(Solutions)

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Example 9-1
Note that if cash dividends are debited directly to the Retained earnings account (instead of being debited to the Cash
dividends declared account), there is no need to close the Cash dividends declared account.
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1 This account is a contra equity account; it is not a liability.

2 Share dividends are recorded using the market/fair value on the date of declaration.
3 Notice that no assets are being distributed to the shareholders as a result of a share dividend, unlike a cash dividend where
cash, an asset, is distributed to shareholders.
Analysis component:
The market price of Delwares shares decreased as a result of the 5% share dividend because given that the number of shares
issued and outstanding increased with no additional asset investment by shareholders, the value will decrease per share
(assuming no changes other than the share dividend). Since the share price is recovering after the declaration of the share
dividend (as evidenced by the market price increase from January 20 to January 30 of $13.50 to $14.25), it can be assumed that
shareholders have a positive future outlook for this company.
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file:////cgafs2/VOL1/Courses/2010-11/CGA/FA1/06course/m09t09sol2.htm
Analysis component:
The market price of Stingrays shares decreased by about 2/3 as a result of the 3:1 share split because although the number
of shares tripled, no new assets were contributed by the shareholders as a result of the share split. If the number of shares
triples with no assets contributed, it is logical that the market value per share would decrease by a ratio equivalent to the
increase in the number of shares.
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file:////cgafs2/VOL1/Courses/2010-11/CGA/FA1/06course/m09t13analysis.htm
Analysis
A reasonable approach to this case is to start by identifying the facts and the operational issues. The facts are clearly stated
in the case. It is important to recognize, however, the conflict between the managers fiduciary responsibility to the
shareholders and their apparent desire to increase their personal wealth through the share option plan. If the information
about the new contract can be kept private until after the option plan is approved and the options are priced, the managers
will stand to make much more money when they eventually exercise those options. The officers suggestion that annual
meetings are only about the companys past activities is misleading because shareholders are being asked to vote on the
three-year stock option plan for managers. Moreover, the general point of annual meetings is to provide an opportunity for
the board to be accountable to shareholders.
This case raises both legal and moral issues. It is against the law to mislead the capital markets by distributing false
information or by withholding relevant information. The managers decision to withhold the news is objectionable because of
the share option plan. The financial vice-president should impress upon the officers and directors that withholding
information about the contract would be unethical.
Some economists and philosophers argue that rules against insider trading dont work and that markets would be more
efficient if there were no prohibitions of insider trading. So while there would not be a level playing field for investors (insider
investors would know far more than investors on the outside), the market would respond more quickly and efficiently to new
information and the rest of the market would learn the information quickly. Moreover, these critics claim that with no rules
against insider trading, other investors (outsiders) would factor in their relative lack of knowledge in making investment
decisions by hiring more knowledgeable investment experts, for example.
It is important to realize that the argument about which type of market arrangements would be more efficient one with
restrictions on insider trading and one with no restrictions is a theoretical one. It is
not an argument that under our current arrangements (which strongly restrict insider trading), it is acceptable to act
in violation of the securities regulations and to take advantage of uninformed investors, who trust that investments will
generally be made on the basis of publicly available knowledge.
You can rightly argue that rules against insider trading should be weakened or even abolished. But it is definitely wrong to
engage in insider trading in a market that has rules against it. This is to take unfair advantage of others. This is like driving
on the left-hand side of the road in Canada and justifying this by claiming that it is required to drive on that side in Japan. In
other words, it is one thing to argue about whether one set of rules is more desirable than another, but quite another to act
on that belief when the general rule in place is the opposite.
For human interactions (including economic interactions) to work well, we have to agree on certain ground rules and trust
that they are in place. Once the ground rules are in place (whether these permit or forbid insider trading), it is unfair to act
as if those rules do not exist. Moreover, to act in such an unfair way undermines the trust that makes productive human
interactions possible.
The ethical bottom line in this case is then crystal clear. The managers are acting unethically in withholding this information
from the shareholders, and they are undermining the trust that is essential to capital markets.
file:////cgafs2/VOL1/Courses/2010-11/CGA/FA1/06course/m09t13analysis.htm [12/07/2010 4:03:29 PM]

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file:////cgafs2/VOL1/Courses/2010-11/CGA/FA1/06course/m09intro.

Module 9: Accounting for partnerships and corporations

Test your knowledge

9.3 Explain the advantages, disadvantages, and organization of corporations. (Level 2)

9.5 Record the issuance of shares. (Level 1)

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Print this module

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Module 9 Test your knowledge

1. Current asset account

4. What are shares that carry voting rights called?

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9.1 Characteristics of proprietorships and partnerships

Chapter 14, pages 694-699

Advantages and disadvantages of a proprietorship

The text describes the characteristics of general partnerships on pages 695-697.

Checkpoint Questions 1 and 2 on

Quick Study 14-1 and 14-2 on page 721

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Accounting for partnerships is explained on page 698 of the text.

Checkpoint Question 3 on page 699

Quick Study 14-3 on page 721 (Solution)

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9.2 Division of partnership earnings

Chapter 14, pages 699-704

Nature of partnership earnings

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9.3 Corporate organization

Explain the advantages, disadvantages, and organization of corporations. (Level 2)

Chapter 15, pages 734-739

Checkpoint Question 1 on page 739

Quick Study 15-1 and 15-2 on page 764

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9.4 Corporate financial statements

Chapter 15, pages 739-741

Statement of comprehensive income (non-examinable)

Statement of changes in equity

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7 FRS 2009, IAS 1 , para. 10 and para. 106-110

Source: Larson and Jensen, Fundamental Accounting

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Accumulated other comprehensive income (non-examinable)

Checkpoint Questions 2, 3, and 5 on

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9.5 Issuance of shares

Record the issuance of shares. (Level 1)

Chapter 15, pages 741-744

Authorized, issued, and outstanding shares

Authorized refers to the number of shares a corporation is permitted to issue.

Checkpoint questions 6 and 7 on

Quick Study 15-8 and 15-9 on page 766

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9.6 Classes of shares and special features of preferred shares

Chapter 15, pages 744-747 and 750-754

The Canada Business Corporations Act

Special features of preferred shares

Checkpoint Questions 8 and 9 on

Judgement Call on page 747 (Solution on page 756)

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9.7 Cash dividends and closing entries for a corporation

Chapter 15, pages 749-750 and 754-755