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Unformatted text preview: Chapter Eleven CHAPTER 11 CORPORATIONS―AN INTRODUCTION SOLUTIONS TO REVIEW QUESTIONS 1. By law, a corporation is recognized as an entity which has the power to act on its own behalf and enter into enforceable legal agreements. It can own property, sell and lease property, and borrow funds in the same way that an individual can. Although the corporation is owned by its shareholders, the affairs of the corporation are separate from the affairs of its owners. Therefore, property owned by the corporation is not property owned by the shareholder, and debts of the corporation are not debts of the shareholders. As a separate entity, the corporation is subject to income tax on its profits. However, when those after-tax profits are distributed to the shareholders they are again included in the shareholders income for tax purposes [S.12(1)(j)]. 2. A shareholder can have both a primary and a secondary relationship with the corporation. Under a primary relationship, the shareholder provides equity capital to the corporation in exchange for shares. The shareholder can receive a return from the shares in the form of dividend distributions and/or share value enhancement. Under a secondary relationship, the shareholders may also act as a creditor, supplier, customer, employee, or lessor to the corporation. They can, therefore, loan money to the company in exchange for interest, lease property to the company in exchange for rent, provide services in exchange for salary and so on. 3. The following factors may influence the value of a corporation's common share capital. • Profits earned or losses incurred by the corporation. Profits retained belong to the common shareholders and the share value increases accordingly. • Dividends paid by the corporation. Dividend distributions reduce the equity of the corporation and the share value declines accordingly. • Increases or decreases in the value of assets owned by the corporation, including tangible assets such as land and buildings, and intangible assets such as goodwill. 4. A shareholder who provides share capital to a corporation can realize a return on investment from dividends or from capital gains when shares that have increased in value are sold. The two are related because dividend payments alter the value of the shares, thereby affecting the potential capital gain (loss) on sale. If after-tax corporate profits are retained by the corporation, the value of the shares increases, which may create a capital gain if the shareholder sells the shares. On the other hand, if corporate earnings are distributed as a dividend, the value of 199 Chapter Eleven the shares decline and reduce the amount of capital gain that would otherwise occur when the shares are sold....
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- Fall '11