Shareholders' Equity

Introduction

The Conceptual Framework provides a deceptively simple definition for equity: "the residual interest in the assets of the entity after deducting all its liabilities" (CPA Canada, 2016, Part I, The Conceptual Framework for Financial Reporting, 4.4 (c)). This definition confirms the most elementary principle in accounting, which is embodied in the accounting equation: Assets = Liabilities + Equity. This apparent conceptual simplicity is further confirmed by the fact that IFRS does not actually contain a separate handbook section devoted to shareholders' equity. However, despite this lack of structured guidance, we should not define equity as a simple concept that doesn't require much attention. On the contrary, there are a number of ways in which the accounting, presentation, and disclosure of equity transactions can be quite complex. Although equity is the residual interest of the business's owners, it is not simply a plug figure used to balance the accounting equation. In this chapter, we will discuss some of the complexities in accounting for equity transactions and we will look at the presentation and disclosure requirements for what can be legally complicated instruments.

Chapter Organization

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Source: Glenn Arnold and Suzanne Kyle, https://lifa1.lyryx.com/textbooks/ARNOLD_2/marketing/ArnoldKyle-IntermFinAcct-Vol2-2020A.pdf
This work is licensed under a Creative Commons Attribution 4.0 License.

18.1 What is Equity?

Despite the simple definition initially provided, the Conceptual Framework does expand on the concept of equity by explaining that funds contributed by shareholders, retained earnings, and other reserves may require separate disclosures. The reasons given for a more detailed disclosure include the objective of providing information about legal restrictions on the distribution of equity that may be useful to investors for decision-making purposes, and the need to disclose the different legal rights that may attach to the various types of equity interests. The Conceptual Framework also notes that although, by definition, equity is affected by the measurement of assets and liabilities, the amount of equity reported would only coincidentally be equal to the current market value of a company. This is an important point, as it highlights one of the limitations of financial reporting: that financial statements by themselves cannot tell an investor what a company is worth.

The components of equity will vary from business to business and will be affected by the type of legal structure adopted by the business. This chapter will focus on the accounting used in the most common type of business organization – the corporation. Accounting and disclosure for other types of entities, such as proprietorships and partnerships, will be different. However, the same basic principles apply to those types of entities as well. Let's now look at the various components of equity, using the classification from the Conceptual Framework: funds contributed by shareholders, retained earnings, and reserves.

18.1.1 Funds Contributed by Shareholders

The funds contributed by shareholders are often the initial capital used to start a business. These funds are often referred to as contributed capital. In a corporate structure, contributed capital will take the form of shares, which can be classified into several different types. Shares, themselves, are legal instruments that provide certain rights to the holder and indicate a residual interest in the corporation's assets. When a company is created, its incorporating documents will specify the maximum number of shares that can be issued. In some cases, this amount, referred to as authorized shares, may be specified as unlimited, meaning the company can issue as many shares as it wants. From an accounting perspective, the number of authorized shares is not relevant but the number of issued shares is. Issued shares are shares that have been issued to shareholders, usually in exchange for money, services, or other assets. Sometimes, a company may repurchase its own shares and keep them in treasury, in which case the number of issued shares will be greater than the number of outstanding shares (those shares held by parties outside of the company). In some jurisdictions, shares can be issued with a par value. This is the stated value of the share and will be directly indicated on the share certificate. Where par value shares exist, the actual issue price may differ from the par value. Amounts received by the corporation in excess of the par value represent another form of contributed capital. This amount will be reported separately from the par value of the shares and is often described as either contributed surplus or share premium. Note that many jurisdictions do not allow par value shares, meaning the issue price would simply be reported as the share capital amount. Shares can be stratified into different classes, based on the different rights and characteristics. We will discuss some of these different characteristics below.

Common Shares

Common shares, also referred to as ordinary shares, represent the final residual interest in a company's assets after all other claims, including other equity interests, have been satisfied. In some companies, these are the only types of shares issued. These shares represent the greatest level of risk to an investor should the company fail, as all other claims against the company's assets would need to be paid first. On the other hand, these shares also represent potentially the greatest rewards, as all the profits not otherwise allocated to debt and equity holders would belong to the common shareholders. All companies must have at least one class of common shares, although they are not always described this way. If a company issues more than one class of shares, and the other classes have additional rights over the common shares, then those classes are not common shares. Rather, they would be described as preferred shares.

Preferred Shares

Preferred shares, also known as preference shares, have special rights and privileges that give them priority over the common shares. These special privileges are often included to make the shares more attractive to investors. As well, the special rights can allow for complex ownership structures where certain groups or individuals want to maintain a degree of control. Because the preferred shares have special rights over the common shares, they are not considered a residual interest. In the event of a business's liquidation, the preferred shareholders would rank ahead of the common shareholders in the priority of payment, but they would still be subordinated to the debt holders.

Preferred shares have many different features that can be combined in multiple configurations to provide many classes of shares for investors to choose from. However, to gain these special features, preferred shareholders often give up certain rights as well, most commonly, the right to vote on the company's management. In many corporate structures, only the common shareholders have the right to vote for the board of directors, even though there may be several classes of shares. It is also important to note that the classes of shares may not always be described as common or preferred in the incorporation documents. The accountant must always be careful to closely examine the economic substance of the share features, and not just rely on the descriptions used by the company.

Let's now look at some of the features of preferred shares.

• Fixed Dividend: Preferred shares often have a fixed dividend amount, usually expressed as a numerical amount per share or sometimes as a percentage of the par value of the share. For example, a preferred share could be entitled to a dividend of 5% of the par value, or $5 per share. These dividends would be equivalent if the share were issued at, or had a par value of, $100. Although the dividend amount is stated, this does not guarantee that the preferred shareholder will receive the dividend in any given year. Dividends must always be declared by the board of directors, and the directors have the discretion not to pay a dividend. However, when dividends are declared the holders of the preferred shares must be paid their stated dividends first before any distributions can be made to the common shareholders.
• Cumulative Dividend: If the directors do not declare a dividend in a current year, the holders of cumulative preferred shares would be entitled to payment of the dividend in a future year. For this type of share, undeclared dividends will accumulate at the stated rate for each year and must all be paid before any dividends can be paid to the common shareholders. These unpaid dividends do not represent a liability until the directors declare a dividend. Preferred shares can also specify a noncumulative dividend, which means any undeclared dividends in a given year are simply lost and are not required to be paid in future years.
• Participating Dividend: When a preferred share is described as participating, it retains the right to receive not only the stated amount of dividends, but also additional dividends based on certain criteria. A typical participation calculation would involve first determining the fixed dividend on the preferred shares, and then allocating a similar proportion to the common shares. Then, additional dividends beyond these two amounts would be shared between the preferred and common shares on a pro-rata basis. There are other, more complex, ways in which participation can be calculated. The specific features of the preferred share would need to be examined to determine the method of calculation. The participation feature can make a preferred share more attractive to investors, as it provides the stability of the fixed dividend, plus the ability to receive further dividends if the company is successful.
• Redemption: A preferred share may be described as being redeemable. This means the company has the right to call the shares and repurchase them at a specified price during a specified time period. When the shares are redeemed, any dividends in arrears must be paid.
• Retraction: This feature is attractive to shareholders, as it allows them the right to require the company to repurchase the shares at a set price. Usually, time limits are set for the retraction period.
• Convertibility: Some preferred shares retain the right to be converted into common shares. The holder may choose to do this if the company has been successful and if common dividends exceed the amount that can be earned by the fixed, preferred dividend. The amount of common shares that can be obtained on conversion will be specified as a ratio, such as two common shares for each preferred share held

Any or all of these features can be attached to classes of preferred shares. Many companies will report multiple share classes, each with different features. In some cases, the features included in a preferred share may suggest that its economic substance is more akin to debt rather than equity. These types of shares should be classified as liabilities, and their dividends would be classified as financing costs on the income statement. Shares with these features are discussed further in Chapter 14: Complex Financial Instruments.

18.1.2 Retained Earnings

The retained earnings account is a separate category of equity that represents the cumulative amount of profit earned by the company since its inception, less the cumulative amount of dividends declared. Sometimes, either as a management choice or as a legal requirement, certain portions of the retained earnings are set aside or appropriated. Appropriations of retained earnings are created to ensure that dividends are not paid from these balances, and these appropriations need to be reported separately. When the retained earnings account falls into a negative (debit) balance, it is usually referred to as a deficit, or retained losses. Retained earnings are sometimes subject to other types of accounting adjustments, such as accounting policy changes and error corrections, which are discussed in other chapters.

18.1.3 Reserves

The term reserves can refer to a number of different accounts. The previously noted appropriations of retained earnings are normally described as reserves. Another type of reserve is accumulated other comprehensive income (AOCI). As discussed in other chapters, comprehensive income results from recognition of income or expense items that are not included in the calculation of net income. There are only a few items that fall into this category, the most common of which are gains resulting from the application of the revaluation method for property, plant, and equipment, and intangibles; re-measurements of defined benefit plans; and gains resulting from remeasurement of available-for-sale financial instruments. These transactions create reserves that must be reported separately on the balance sheet. However, they may not always be described as accumulated other comprehensive income. For example, the term revaluation surplus is often used instead. Regardless of the name, the reserves must clearly identify the source of the surplus, and separate reserves are required for each type of item

18.2 Issuing Shares

When a company is first incorporated, it will be authorized to issue a certain number of shares. This authorization does not, in and of itself, create any accounting transaction that needs to be recorded. However, after the shares are authorized they can be issued, which creates an accounting transaction. We will look at several examples of different types of share issuances.

Shares Issued for Cash

This is the simplest scenario: shares will be issued to the holder in exchange for a cash payment. For example, if 10,000 common shares are issued at a price of $10 each, the journal entry would be:

General Journal
Date	Account/Explanation	PR	Debit	Credit
	Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .		100,000
	Common shares . . . . . . . . . . . . . . . . . . . . . . . . .			100,000

Note: Each class of shares should be recorded in a different account, as the disclosure of the amounts of different classes of shares is required. Also, when brokerage houses, agents, lawyers, and other professionals are involved in issuing the shares, any fees or commissions charged by these parties should be directly deducted from the share capital amount.

Par Value Shares Issued for Cash

In the example above, the net amount of cash received simply becomes the stated capital amount of the shares. In some jurisdictions, shares are authorized with a par value, which is a value that will be directly stated on the share certificate. However, as market conditions will dictate the actual issue price of the shares, it is possible that an amount greater than the par value will be received when the shares are issued. The excess amount over the par value still represents contributed capital, but it must be recorded separately. If, for example, 5,000 shares with a par value of $2 per share are issued for $8, the journal entry would be:

General Journal
Date	Account/Explanation	PR	Debit	Credit
	Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .		40,000
	Common shares . . . . . . . . . . . . . . . . . . . . . . . . .			10,000
	Contributed surplus . . . . . . . . . . . . . . . . . . . . . .			30,000

The contributed surplus amount will be reported as part of the contributed capital on the balance sheet. This account is sometimes described as share premium or additional paid-in capital.

Subscribed Shares

Sometimes a company may offer shares on a subscription basis, allowing the holder to pay for the shares in a series of payments. The accounting for these types of transactions will depend on local legislation, the terms of the subscription contract, and corporate policy. We will look at a few different examples of these types of transactions.

Scenario 1

A company offers to issue its shares in blocks of 20 at a price $60 per share. The contract requires a 25% down payment with the remaining 75% payable in six months, and 100 individuals accept the offer. Local legislation does not allow shares to be issued until they are fully paid. The following journal entries are required:

General Journal
Date	Account/Explanation	PR	Debit	Credit
When shares are first subscribed	Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .		30,000
	Share subscription receivable . . . . . . . . . . . . . . .		90,000
	Common shares subscribed . . . . . . . . . . . . . For Cash: (100 × 20 × $60 × 25%) For Share subscription: (100 × 20 × $60 × 75%)			120,00

The share subscription receivable conceptually does not represent a receivable in the conventional sense, as it represents a capital and not an income transaction. As such, the most appropriate treatment would be to show it as a contra-equity account. However, some argue that because it does represent a future benefit to the company, it should be reported as an asset. Both presentations can be found in practice. The common shares subscribed account should be shown as part of the contributed capital section, but it should be segregated from the issued share capital.

In six months' time, the following journal entry is required:

General Journal
Date	Account/Explanation	PR	Debit	Credit
When shares are paid	Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .		90,000
	Share subscription receivable . . . . . . . . . . . . . . .			90,000
	Common shares subscribed . . . . . . . . . . . . .		120,00
	Common shares . . . . . . . . . . . . . . . . . . . . . . . . .			120,00

Note: If a dividend is declared between the subscription date and the final payment date, the treatment of that dividend will depend on local legislation. Although it is likely that the shares will not be eligible for dividends, as they have not yet been issued, some jurisdictions allow the distribution of a pro-rata dividend based on the amount of cash received to date. In our example, the subscribers would be eligible for 25% of the regular dividend amount declared. Similarly, if a shareholders' meeting is held during this interim period, the subscribers may be eligible for a pro-rata share of votes at the meeting.

Scenario 2

Let's assume the same set of facts as Scenario 1, except that 10 of the subscribers default on their final payments. At the time of the initial subscription, the journal entry will be identical to the one used in Scenario 1. However, at the time of final payment, the journal entry will depend on local legislation, the subscription contract, and corporate policy. If we assume that legislation requires a refund of the initial deposit to the defaulting subscribers, then the journal entry would look like this:

General Journal
Date	Account/Explanation	PR	Debit	Credit
When 90% of the shares are paid	Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .		81,000
	Share subscription receivable . . . . . . . . . . . . . . .			90,000
	Common shares subscribed . . . . . . . . . . . . .		120,00
	Common shares . . . . . . . . . . . . . . . . . . . . . . . . .			108,000
	Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . For Cash: (90 × 20 × $60 × 75%) For Common shares: ($120,000 × 90%) For Accounts payable: ($30,000 × 10%)			3,000

Scenario 3

Let's assume the same set of facts as Scenario 2, except that local legislation allows shares to be issued to defaulting subscribers pro-rata, based on the amounts of their deposits. The journal entry on issuance would look like this:

General Journal
Date	Account/Explanation	PR	Debit	Credit
When 90% of the shares are paid	Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .		81,000
	Share subscription receivable . . . . . . . . . . . . . . .			90,000
	Common shares subscribed . . . . . . . . . . . . .		120,00
	Common shares . . . . . . . . . . . . . . . . . . . . . . . . . For Cash: (90 × 20 × $60 × 75%) For Common shares: (($120,000 × 90%) + (10 × 20 × $60 × 25%))			111,000

In some cases, the company may charge a fee to the defaulting subscribers, which would be allocated to contributed surplus, rather than to common share capital.

Scenario 4

Let's assume the same set of facts as Scenario 2, except that local legislation allows the company to keep the defaulting subscribers' deposits. In this case, the following journal entry is recorded at issuance:

General Journal
Date	Account/Explanation	PR	Debit	Credit
When 90% of the shares are paid	Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .		81,000
	Share subscription receivable . . . . . . . . . . . . . . .			90,000
	Common shares subscribed . . . . . . . . . . . . .		120,00
	Common shares . . . . . . . . . . . . . . . . . . . . . . . . .			108,000
	Contributed surplus . . . . . . . . . . . . . . . . . . . . . . For Cash: (90 × 20 × $60 × 75%) For Common shares: ($120,000 × 90%) For Accounts payable: ($30,000 × 10%)			3,000

Shares Issued for Goods or Services

Sometimes a company may issue shares in exchange for assets other than cash, or in exchange for services provided. These situations may occur when a company is in the start-up phase of its life cycle and wishes to preserve scarce cash resources. In these cases, the shares should be recorded at the fair value of the asset acquired or service received. Note that this treatment is different than the treatment of non-monetary exchanges of assets, where the fair value of the asset given up is normally used as the transaction amount. This difference results because fair values of assets or services are usually more reliable than fair values of shares. In the rare circumstance that the fair values of the assets or services cannot be determined, the fair value of the shares issued should then be used. This value is obviously easier to determine for a publicly traded company. In all cases, non-monetary exchanges for shares will involve the exercise of good judgment on the part of the accountant.

A company may also issue its shares in exchange for shares of another company. This type of business combination is an advanced financial accounting concept that is not covered in this text.

18.4 Dividends

Cash Dividends

For investors, receiving dividends represents one of the essential motivations for holding shares. Although many established companies may have a policy of paying regular and predictable dividends, shareholders understand that there is no automatic right to dividends. The payment of dividends is decided by the board of directors and is based on several relevant criteria. First, the dividend must be legal. The rules for dividends vary by jurisdiction, but essentially the company must have sufficient distributable profits to pay the dividend. Some jurisdictions have complex methods of calculating this amount, but it can often be approximated using the balance in the retained earnings account. The purpose of limiting the dividends is to ensure that the company is not left in a position where it cannot pay its liabilities. Directors need to be aware of the legal requirements for dividend payments, as the payment of an illegal dividend could result in personal liability to the director if the company cannot, subsequently, pay its creditors. Second, the company must have sufficient cash to pay the dividend. Cash flow planning is important to the management of a business, and although the company may have sufficient retained earnings to declare a dividend, it may not have the cash readily available. Remember that the retained earnings balance does not equal cash, as companies will invest in many different types of assets. Third, the dividend must fit with the company's strategic priorities. A company that is able to pay dividends may choose not to in order to preserve cash for various future uses, such as reinvestment in capital assets, funding strategic acquisitions, entrance into new markets, funding share buybacks, and committing to research and development. As well, a company may not want to pay the maximum dividend it is legally entitled to because it does not want to create unrealistic expectations among shareholders for future dividends.

Once the directors have decided to declare a dividend, three significant dates need to be considered. First, the date of declaration is the date the board of directors meets to approve the dividend payment. This will be formally documented as a directors' resolution, and it is on this date that a liability is created, for both legal and accounting purposes. Second, in the directors' resolution, the date of record will be specified, which is the date on which a list of the shareholders who will receive dividends is compiled. Obviously, between the date of declaration and the date of record, shares will trade at a price based on the understanding that whoever holds the shares on the date of record is eligible for the dividend. Note, for many public stock exchanges, an ex-dividend date may also be relevant. This is a date several days before the date of record, which allows a period of time for share transactions to be processed. Third, sometime after the date of record is the date of payment. It is on this day that dividend payments are distributed to the shareholders of record.

Consider the following example. A company with 500,000 outstanding common shares declares a dividend of $0.75 per share on January 20. The resolution indicates a record date of January 31 and a payment date of February 15. The following journal entries would be made on each date:

Declaration date:

General Journal
Date	Account/Explanation	PR	Debit	Credit
Jan 20	Dividends declared (retained earnings). . . . . .		375,000
	Dividends payable . . . . . . . . . . . . . . . . . . . . . . . Dividends are calculated as 500,000 × $0.75 = $375,000			375,000

Note: The debit can either be made to a temporary account called Dividends declared, which will be closed to retained earnings at year-end, or it can be made directly to retained earnings.

Date of record:

General Journal
Date	Account/Explanation	PR	Debit	Credit
Jan 31	No entry required . . . . . . . . . . . . . . . . . . . . . . . . . . .

No entry is made here, as the date of record does not represent an accounting event

Date of payment:

General Journal
Date	Account/Explanation	PR	Debit	Credit
Feb 15	Dividends payable . . . . . . . . . . . . . . . . . . . . . . . . . .		375,000
	Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .			375,000

Note: The dividends can be expressed as a per share amount, or they may be described as a percentage of the share's par value. Also, no dividends are paid on treasury shares as the company cannot pay itself.

Property Dividends

In certain instances, a company may choose to pay a dividend with assets other than cash. This could include shares of other companies held as investments, property, plant and equipment, inventory, or any other asset held. These types of transactions are rare for three obvious reasons: 1) the asset must be equally divisible among all holders of a particular class of shares, 2) the fair value of the asset needs to be determined, and 3) the asset must be able to be physically distributed to the shareholders. When the company can overcome these restrictions, the property dividend will be recorded in a manner similar to the journal entries previously identified. There will be an additional step, however, in that the asset must first be revalued to its fair value before the dividend is distributed. This will usually result in a gain or loss being recorded, which is appropriate as the asset is being disposed of to settle a liability.

Share Dividends

One way that a company can distribute a dividend to shareholders without depleting its cash resources is to pay a share (stock) dividend. This dividend distributes additional shares of the company to the shareholders proportional to their current holdings. For example, if a company declares a 5% share dividend, a shareholder who currently holds 100 shares would receive an additional five shares. Although there may be some complicated jurisdictional legal requirements regarding share dividends, the general principle is that they should be recorded at the fair value of the shares issued.

Consider the following example. A company currently has 100,000 shares outstanding that are trading at $5.25 per share. The company decides to declare a 5% share dividend, which means an additional 5,000 shares will be issued to existing shareholders (100,000 × 5%). Immediately prior to the dividend declaration, the implied value of the company is $525,000 (100,000 × $5.25). Because a share dividend does not have any effect on the assets or liabilities of the company, we would expect the total value of the company to remain the same after the dividend. However, we would expect the market price per share to drop to $5.00 per share ($525,000 ÷ 105,000), as the value is now spread among more shares.

The journal entries to record this transaction, assuming the share price drops to $5 as expected, would be as follows:

Declaration date:

General Journal
Date	Account/Explanation	PR	Debit	Credit
	Dividends declared (retained earnings). . . . . .		25,000
	Share dividends distributable . . . . . . . . . . . .			25,000

Payment date:

General Journal
Date	Account/Explanation	PR	Debit	Credit
	Share dividends distributable. . . . . . . . . . . . . . . .		25,000
	Common shares . . . . . . . . . . . . . . . . . . . . . . . . .			25,000

Note: The fair value we use to determine the amount is the post-dividend (sometimes referred to as ex-dividend) value of $5.00 per share × 5,000 shares = $25,000. Also, if the company's year-end were to fall between the declaration date and the payment date, then the share dividends distributable balance would be reported in the equity section of the balance sheet, as it does not represent a liability like a cash dividend payable.

Declaring a share dividend causes part of the company's retained earnings to become capitalized as contributed capital (common shares). By doing so, the company has removed this portion of retained earnings from the pool of distributable earnings that can be later used to pay cash dividends.

Share Splits

Share splits, also known as stock splits, scrip issues, or bonus issues, are similar to share dividends except they have a different accounting treatment. Generally, the motivation for a share split is to reduce the market price of the share. For example, if the share price has risen to a point where it is no longer affordable, this makes it difficult for the company to sell shares to the public. A share split will be expressed as a proportion, such as a 2-for-1 split. This means that for every share held an additional share will be issued. Thus, after the 2-for-1 split, the number of outstanding shares will be twice the previous number. This will normally have the effect of reducing the market price of the share by half, so that the total market capitalization remains unchanged.

Because there is no change in the economic resources or position of the company, no journal entry is required to record a share split. However, a memorandum entry should be made, noting the new number of shares. This will be important in the future for the purposes of calculating dividend payments and earnings per share amounts.

In some cases, it may be difficult to distinguish between a share split and a large share dividend. For example, the effects of a 100% share dividend and a 2-for-1 share split are essentially the same. As IFRS does not provide any specific guidance on this issue, professional judgment and consideration of the relevant legal framework will be required in determining how to record large share dividends.

A company may also engage in a reverse share split, sometimes referred to as a share consolidation. This will reduce the number of outstanding shares by a certain proportion. This type of transaction is usually motivated by the need to increase the market price of a share.

18.4.1 Preferred Share Dividends

As noted previously, a feature of preferred shares is that they often receive preferential treatment when dividends are declared. We will now look at some examples of how dividends are calculated when preferred shares are outstanding.

Assume a company has two classes of shares: 1) common shares, of which 100,000 are outstanding with a carrying amount of $480,000, and 2) preferred shares with a fixed dividend of $2 per share, of which 20,000 are outstanding with a carrying amount of $320,000. In the current year, the company has declared total dividends of $120,000. Dividends will be allocated to each class of shares as follows:

a. Preferred shares are non-cumulative and non-participating:

Calculation	Preferred	Common	Total
Current year: 20,000 shares × $2	$ 40,000		$ 40,000
Balance of dividends ($120,000 − $40,000)	-	$ 80,000	80,000
	$ 40,000	$ 80,000	$120,000

b. Preferred shares are cumulative and non-participating, and dividends were not paid last year:

Calculation	Preferred	Common	Total
Arrears: 20,000 shares × $2	$ 40,000		$ 40,000
Current year: 20,000 shares × $2	40,000		40,000
Balance of dividends ($120,000 − $80,000)	-	-	40,000
	$ 120,000	-	$120,000

c. Preferred shares are cumulative and non-participating, and dividends were not paid for the last two years:

Calculation	Preferred	Common	Total
Arrears: 20,000 shares × $2 × 2 years	$ 80,000		$ 80,000
Current year: 20,000 shares × $2	40,000		40,000
Balance of dividends ($120,000 − $120,000)	-	-	-
	$ 80,000	-	$120,000

d. Preferred shares are non-cumulative and fully participating:

Calculation	Preferred	Common	Total
Current year basic dividend	$ 40,000	$ 60,000	$100,000
Current year participating dividend	$ 8,000	$ 12,000	20,000
	$ 48,000	$ 72,000	$120,000

Note: The basic preferred dividend is calculated as before. Then, a like amount is allocated to the common shares. The preferred dividend can be expressed as a percentage: $40,000 ÷ $320,000 = 12.5%. Therefore, the common shares are also allocated a basic dividend of (12.5% ×$480,000) = $60,000. This leaves a remaining dividend of $20,000, which is available for participation. The participation is allocated on a pro-rata basis as follows:

Carrying amounts of each class:

Preferred	$320,000	40%
Common	480,000	60%
Total	$800,000	100%

 The participating dividend is therefore:

Preferred	$20,000 × 40% = $ 8,000
Common	$20,000 × 60% = $12,000

If the preferred shares were cumulative and fully participating, the process followed is the same as above, except the dividends available for participation must be reduced by any preferred dividends in arrears, as these must be paid first before any dividends can be paid to common shareholders.

The pro-rata allocation of the participating dividend, shown above, is one way to determine the rate of participation. However, if a company's articles of incorporation specify other methods of participation for different classes of shares, then these calculations must be applied instead.