Equity

• Author: Vern Krishna
• Pages: 207-237

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Chapter : Equity

A. OVERVIEW

Corporations present unique problems in law because of the special

nature of separate corporate existence and limited liability to creditors.

We have seen that the fundamental accounting equation distinguishes

between debt and equity capital on the balance sheet. Hence, the

equation, A = L + E, takes on special meaning in the context of corpor-

ate accounting. e equation can be restated as E = A − L, whereby E

represents the theoretical residual amount to which the shareholders

of the corporation are entitled after it discharges all of its liabilities

from corporate assets.

e capital structure of an enterprise has two elements, debt and

equity capital, each of which has distinct rights and obligations in the

law. us, the characterization of capital as either debt or equity is

important in corporate and tax law.

ere are two signicant legal restrictions on corporate capital:

) Corporations can generally only issue shares for the consideration

that they receive in payment for the shares. Most jurisdictions

generally require a corporation to add the full amount of the con-

sideration it receives for any shares that it issues to the appropriate

 Financial Skills for Professionals

stated capital account. is restriction is the prerequisite condi-

tion for limiting the personal liability of shareholders.

) ere are strict restrictions on a corporation’s ability to distribute

its assets to its shareholders.

Each of these restrictions has important legal, nancial, and tax con-

sequences in corporate nance.

B. SHAREHOLDERS’ EQUITY

Equity capital is divided into two broad categories: () share capital

and () retained earnings.

e following is a partial balance sheet of our hypothetical com-

pany, Duggan Inc, as at  September.

Shareholders’ Equity (thousands of dollars) 

$



$

Class A shares:

Authorized — unlimited

Issued and outstanding  

Retained earnings  

Treasury shares at cost − −

Total shareholders’ equity  

Total Liabilities & Shareholders’ Equity  

. Share Capital

“Capital” means many things in nance. For example:

• Share capital contributed by the owners of the business;

• Loan capital provided by creditors of a business;

 See, for example, Canada Business Corporations Act, RSC, , c C- [CBCA],

s (); the Ontario Business Corporations Act, RSO , c B [OBCA], s();

and the Alberta Business Corporations Act, Alta Reg / [ABCA], s().

There are limited exceptions for shares issued to non-arm’s length person in

certain types of tax transactions. See also CBCA, s (), OBCA, s (), and

ABCA, s ().

 See, for example, CBCA, ss , , , , and .