Financing
activities
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Table of contents
01 02 03
Equity Debt Hybrid
financing financing securities
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01 Equity financing
Book value of shareholders’ equity:
o The amount of shareholders’ equity reported in the balance sheet.
o Is the investment base for equity/net assets used in profitability analysis,
risk analysis and residual income-based equity valuation.
o Shareholders’ equity is affected by:
o Investments by shareholders (Contributed capital)
o Distributions to shareholders (Dividends)
o Profitable operating and investing activities (RE)
01 Investments by Shareholders:
Common Equity Issuance
Measurement: Fair value of what the corporation initially receives.
Accounting: The fair value received is split between two contributed
capital accounts:
o Common stock (par value) and o Company A decides to issue
(Share capital)
100,000 ordinary shares ($1 par
o Additional paid-in capital
(amount of fair value received value). The issue price is actually
that exceeds par value). (Share $1.30 per share.
premium) o How will this issuance be
recorded by company A?
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01 Investments by Shareholders:
Preferred Stock Issuance
Measurement: Fair value of what the corporation
initially receives.
Accounting: The fair value received is split
between two contributed capital accounts:
o Preferred stock (par value)
o Additional paid-in capital (amount of fair value
received that exceeds par value).
o Convertible into common shares or callable at
scheduled dates or at the firm’s discretion.
01 Common Stock vs Preferred Stock
Common Stock Preferred Stock
Priority over Residual Claim Priority over common stock-
liquidation holders
Dividends Company pays dividends if Fixed and regular dividends
from company they wish to do so (no
obligation)
Voting Rights Yes (true ownership) No
Types One type Redeemable vs Irredeemable
Convertible vs Non-
convertible
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01 Distribution to Shareholders: Dividends
Are simply a transfer (usually of cash) to shareholders of a portion of
what they really own, namely, net assets of the firm
The declaration of dividends is o Company A declares and pays
formalized by three important dates: $2,000,000 dividends
o Date of declaration (2,000,000 shares at $1 per
o Date of record share).
o Date of payment
o Show financial statement effect
of the event.
01 Stock dividends and stock splits
o No transfer of asset to Company A distributes 10% stock
investors dividends, market price of $12
o No change in total o Declaration date
shareholders’ equity o Date of record
o No change in proportional o Date of payment
ownership of shareholders
o No change in investor wealth
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01 Share repurchases
Treasury Stock: stock repurchased for reissue at a later date.
Purpose:
o To service the possible exercise of options.
o To shift the mix of debt and equity financing.
o To signal to investors that corporate management believes
the stock is undervalued.
o To tackle a takeover attempt.
01 Equity issued as compensation
Stock option
Stock based compensation: Recording of stock options
Key parameters o Grant date
o Grant date o Exercise date
o Vesting date. o Expiration
o Exercise date o Revocation
o Exercise price
o Market price
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01 Earned capital
Net Income and Retained Earnings
Accumulated Other Comprehensive Income (AOCI)
o Unrealized fair value gains or losses on securities deemed available for sale
o Unrealized gains and losses from translation of foreign financial statements
during the consolidation process
o Unrealized gains and losses from certain hedging activities.
o Unrealized gains and losses from changes in certain pension assets and
liabilities
Reserves
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02 Debt financing
o Principles of Liability Long term debt financing
Recognition o Notes payable
o involves a probable future
sacrifice of economic o Bonds payable
benefits. o Leases
o a present obligation.
o transaction or event has
already occurred.
o Principles of Liability Valuation
o Application of Criteria for
Liability Recognition
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02 Debt financing
o promises to pay principal amounts at specified dates.
o promises to pay cash interest (or lease payments) of specified amounts at
specified dates.
o call provisions.
o descriptions of property pledged as security.
o whether the debt is convertible to another claim and the conversion rate.
o covenants and restrictions that specify sinking fund requirements,
working capital restrictions, dividend payment restrictions, restrictions on
new debt issues, and others.
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03 Notes payable - Application
Assume that on January 1, 2023, The Sigma Corporation borrows money from a bank by
issuing a 100,000 promissory note. The note matures in four years on December 31, 2026,
and pays 5% interest once a year on December 31. Sigma received $103,630, implying that
the bank expects a 4% return on the note.
Interest expense Amortisation of Book value of
Date Cash Payment
(4%* BV of N/P) premium N/P
31/12/2023 5,000 4,145 855 102,775
31/12/2024 5,000 4,111 889 101,886
31/12/2025 5,000 4,075 925 100,962
31/12/2026 5,000 4,038 962 100,000
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03 Notes payable - Application
Recording of notes payable
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04 Hybrid securities
Convertible debt: at the creditor’s option, be converted into common
shares at a prespecified exchange rate
(1) debt with a stated interest rate and maturity date
(2) an option to exchange the debt for equity
US GAAP IFRS
Recording convertible - Financial liability - Financial liability
debt - Equity component
Recording conversion - Both book value and - Both book value and market
market value is allowed value is allowed
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04 Hybrid securities
Example
ABC Company issued 4%, 10-year convertible bonds on January 1 at their
par value of $500 million. Each $1,000 bond is convertible into 50 shares of
ARTL’s $2 par value common stock. Show the financial statement effects
under U.S. GAAP of the original issue, recognition of one year’s interest
effect, conversion of the bonds when a share of ARTL common stock
trades at $30.
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Tutorial exercises
E7-2
E7-3
E7-5
E7-10 (USGAAP only)
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