Download Chapter 11

Chapter 11
Stockholders’ Equity
Using Financial Accounting Information:
The Alternative to Debits and Credits, 6th
by
Gary A. Porter and Curtis L. Norton
Copyright © 2009 South-Western, a part of Cengage Learning
Advantages of
Stock vs. Debt Financing
 Flexibility
 Exchanges
facilitate trading
 Return on
investment
LO1
Disadvantages of
Stock vs. Debt Financing
 Control
 Tax consequences
 Impact on ratios
Expanded Accounting Equation
Assets = Liabilities + Owners’ Equity
Assets = Liabilities + Stockholders’ Equity
Contributed
Capital
Retained
Earnings
Retained Earnings Connects the
Income Statement and Balance Sheet
Income Statement
Revenues
Less: Expenses
Net Income
$
$
xxx
xxx
inc
Statement of Retained Earnings
Retained Earnings, Beginning Balance
Add: Net Income
Deduct: Dividends
Retained Earnings, Ending Balance
$
xxx
inc
xxx
$ end
Balance Sheet
Total Assets
Total Liabilities
Stockholders’ Equity
Retained Earnings
Total Liabilities and Stockholders' Equity
$ xxx
xxx
xxx
end
$ xxx
Stockholders’ Equity Components
Common
Stock
Treasury
Stock
Additional
Paid-in
Capital
Preferred
Stock
Retained
Earnings
Stockholders’ Equity
 Contributed Capital
• The amount the corporation has received
from the sale of the stock to the stockholders
• Normally carries voting rights
 Retained Earnings
• The amount of net income the corporation
has earned but not paid out as dividends
• Income the corporation retains and reinvests
Number of Shares of Stock
Authorized
Maximum
Allowable
Issued: sold or
distributed
Outstanding: not
repurchased or retired
Par Value
 “Legal capital”
 Arbitrary amount stated on stock
certificate
 Also called “stated value”
Additional Paid-in Capital
 Amount received in excess of par when stock
was originally issued
Retained Earnings
 Net income retained in the business (not paid out
as dividends) since its inception
 Reinvested in a variety of assets (not necessarily
liquid or cash)
Preferred Stock
 Can tailor to specific needs of firm
 Stated dividend rate
• Percentage of the stock’s par value
• Per-share amount
 Often carries dividend preference over
common stock
LO2
Preferred Stock Features
 Cumulative:
 Participating
 Callable
 Convertible
Stock Issued for Cash
Example:
1,000 shares of
$10 par value
stock
sold for $15 per
share
Common Stock $ 10,000
( $10 par value × 1,000 shares)
Additional Paid-In Capital $5,000
([$15 – $10] × 1,000 shares)
LO3
Stock Issued for Cash
To record the issuance of 1,000 shares of $10 common stock at $15
per share:
Balance Sheet
Income Statement
Assets
=
Liabilities + Stockholders’ + Revenues - Expenses
Equity
Cash 15,000 =
Common Stock
10,000
Additional Paid in
Capital-Common
5,000
Stock Issued for Noncash
Consideration
 Record at fair market value of consideration
given or received, whichever is more readily
determinable
Building
Common or
Preferred
Stock
Treasury Stock
 Company buys back its own stock
 Contra-equity account (reduces
stockholders’ equity)
 Not outstanding (no voting rights)
LO4
Reasons for Repurchasing Stock
 Provide for employee bonuses or benefit plans
 Maintain a favorable market price
 Improve financial ratios
 Maintain control of ownership
 Prevent unwanted takeover or buyout attempts
Presentation of Treasury Stock
Common stock, $10 par value, 1,000
shares issued, 900 outstanding
Additional paid-in capital—Common
Retained earnings
Total contributed capital and
retained earnings
Less: Treasury stock, 100 shares
at cost ($25 per share)
Total stockholders’ equity
$10,000
12,000
15,000
37,000
2,500
$34,500
Cash Dividends
Date of Paid
declaration to
Stockholders
on date of record
on
Payment
date
LO5
Dividend Requirements
 Sufficient cash
 Positive retained earnings
Dividend Payout Ratio
Annual Dividend Amount
Annual Net Income
The % of
earnings paid
as dividends
Dividends
Entry required to record:
(1) dividends declared
(2) dividends paid
12/31/08
Reduce
retained
earnings
1/15/09
Pay
dividends
Recording Cash Dividends
To record the declaration of a cash dividend:
Balance Sheet
Income Statement
Assets =
Liabilities + Stockholders’ + Revenues – Expenses
Equity
Dividend Payable Retained Earnings
7,000
(7,000)
To record the payment of a cash dividend:
Cash = Dividend Payable
(7,000)
(7,000)
Allocation of Cash Dividends
1. Distribute dividends in arrears, if any, to
preferred
2. Distribute current year’s dividends to
preferred
3. Distribute remainder to common (or to both if
preferred is participating)
Cash Dividends Example
 In 2008, Stricker Company declares a
$70,000 dividend (no dividends were paid in
2006 or 2007).
There are 10,000 shares of $10 par, 8%
preferred stock and
40,000 shares of $5 par common stock
outstanding.
Cash Dividends Example
Noncumulative Preferred Stock
To Preferred To Common
Step 1: Distribute current-year dividend
to preferred (10,000 shares × $10 par ×
8% × 1 year)
Step 2: Distribute remaining dividend to
common ($70,000 – $8,000)
Total allocated
$8,000
$8,000
$62,000
$62,000
$0.80
per
share
$1.55
per
share
Cash Dividends Example
Cumulative Preferred Stock
To Preferred
Step 1: Distribute dividends in arrears
to preferred (10,000 shares × $10 par ×
8% × 2 years)
Step 2: Distribute current-year dividend
to preferred (10,000 shares × $10 par ×
8% × 1 year)
Step 3: Distribute remainder to common
($70,000 – $24,000)
Total allocated
To Common
$16,000
8,000
$24,000
$46,000
$46,000
$2.40
per
share
$1.15
per
share
Stock Dividends
 Issue of additional shares proportionately to
existing stockholders
 Reasons:
• Insufficient cash
• Market price reduction
• Nontaxable to recipients
LO6
Small Stock Dividend Example
Stockholders’ Equity:
Common stock, $10 par, 5,000 shares
issued and outstanding
Additional paid-in capital—Common
Retained earnings
Total stockholders’ equity
Before Dividend
$ 50,000
30,000
70,000
$150,000
Assume Shah Company declares a 10% stock dividend;
500 shares @ $40 per share market value
Small Stock Dividend Example
Before
Stockholders’ Equity:
Common stock, $10 par, 5,500 shares $ 50,000
Additional paid-in capital—Common
30,000
Retained earnings
70,000
Total stockholders’ equity
$150,000
After
$ 55,000
45,000
50,000
$150,000
$40 market value deducted from retained
earnings; allocated between Common Stock
(initially Common Stock Dividend Distributable)
and Additional Paid-in Capital.
+
+
–
Small Stock Dividend Example
Before
After
Stockholders’ Equity:
Common stock, $10 par, 5,500 shares $ 50,000
Additional paid-in capital—Common
30,000
Retained earnings
70,000
Total stockholders’ equity
$150,000
$ 55,000
45,000
50,000
$150,000
+
+
–
Total S/E is unchanged
Large Stock Dividend Example
Before Dividend
Stockholders’ Equity:
Common stock, $10 par, 5,000 shares
issued and outstanding
$ 50,000
Additional paid-in capital—Common
30,000
Retained earnings
70,000
Total stockholders’ equity
$150,000
Assume Shah Company declares 100% stock dividend
Large Stock Dividend Example
Before
Stockholders’ Equity:
Common stock, $10 par, 10,000 shares $ 50,000
Additional paid-in capital—Common
30,000
Retained earnings
70,000
Total stockholders’ equity
$150,000
After
$100,000
30,000
20,000
$150,000
Dividend deducted from retained earnings and
recorded in the Common Stock account at par.
Additional Paid-in Capital account is unaffected.
+
–
Large Stock Dividend Example
Before
Stockholders’ Equity:
Common stock, $10 par, 10,000 shares $ 50,000
Additional paid-in capital—Common
30,000
Retained earnings
70,000
Total stockholders’ equity
$150,000
After
$100,000
30,000
20,000
$150,000
+
–
Total S/E is unchanged
Stock Splits
 Results in additional issuance of shares
 Reduces par value per share
 No change in stockholders’ equity accounts
LO 7
Stock Splits
 Not recorded in accounts
 Reduce market price per share and make the
stock more accessible to a wider range of
investors
 Disclosed in notes
2-for-1 Stock Split Example
Stockholders’ Equity:
Before Split
Common stock, $10 par, 5,000 shares
issued and outstanding
$ 50,000
Additional paid-in capital—Common
30,000
Retained earnings
70,000
Total stockholders’ equity
$150,000
Assume Shah Company declares 2-for-1 stock split
2-for-1 Stock Split Example
Before
Stockholders’ Equity:
Common stock, $5 par, 10,000 shares $ 50,000
Additional paid-in capital—Common
30,000
Retained earnings
70,000
Total stockholders’ equity
$150,000
Only disclosures
are affected
After
$ 50,000
30,000
70,000
$150,000
All accounts are unchanged
Statement of Stockholders’ Equity
 Explains all the reasons for the difference
between the beginning and the ending
balance of each of the accounts in the
Stockholders’ Equity category of the
balance sheet
Statement of Retained Earnings
Beginning retained earnings
Add: Net earnings
Subtract: Dividend(s) declared
= Ending retained earnings
LO8
Statement of
Comprehensive Income
Income Statement
For Year Ended December 31, 20XX
Revenues
xxx
Expenses
xxx
Other gains and losses
xxx
Income before tax
xxx
Income tax expense
xxx
Net income
xxx
Statement of Comprehensive Income
For Year Ended December 31, 20XX
Net income
xxx
Foreign currency translation
adjustment
xxx
Unrealized holding gains/losses
xxx
Delayed recognition of
pension items
xxx
Comprehensive income
xxx
Comprehensive income – the total change in net assets from all
sources except investments by or distributions to the owners
Analyzing Owners’ Equity
 Book value per share
• Rights that each share of common stock
has to the net assets of corporation
 Market value per share
• Price at which stock is currently selling
LO9
Book Value per Share
Total Stockholders’ Equity
Number of Shares of Stock Outstanding
 Amount per share of net assets to which the
company’s common stockholders have the
rights
 Does not indicate the price that should be
paid by those who want to buy or sell the
stock on the stock exchange
Market Value per Share
 The selling price of the stock as indicated
by the most recent transactions
 Usually stated in a 52-week high and low
 More meaningful measure of the value of
the stock than book value
52-week
High
Low Sym
68.17 39.17 GE
Daily
High Low
43.3
Last
42.01 42.93
Change
+0.48 (1.13%)
Stockholders’ Equity Items on
the Statement of Cash Flows
Operating Activities
Net income
Investing Activities
Financing Activities
Issuance of stock
Retirement or repurchase of stock
Payment of dividends
xxx
+
–
–
LO10
Appendix
Accounting Tools:
Unincorporated Businesses
Sole Proprietorships
 Not a separate legal entity so owner has
unlimited liability
 Must keep personal and business records
separate
 Business income is declared on the owner’s
personal tax return and taxed at personal tax
rate
LO11
Sole Proprietorships
Owner invested $10,000 in the business:
Balance Sheet
Income Statement
Assets
= Liabilities + Owners’
+ Revenues -- Expenses
Equity
Cash 10,000 =
Owner, Capital 10,000
Owner withdraws a $6,000 auto from the business:
Equipment =
(6,000)
Owner, Withdrawals
(6,000)
Owners’ withdrawal account are
contra-equity accounts
Sole Proprietorships
 Drawing or withdrawal and income
summary accounts are closed to the owner’s
capital account
 Owner’s Equity section of the balance sheet
consists of the capital account:
Beginning balance
Plus: Investments
Net Income
Less: Withdrawals
Ending balance
$
0
10,000
4,000
(6,000)
$ 8,000
Partnerships
 Unlimited liability
 Limited life – partnership agreements can
and do end
 Not taxed as a separate entity
Partnerships
Distribution of income:
 Equal distribution
 Stated ratio
 Other allocation
• For example, based on salaries, interest on
invested capital, and a stated ratio
End of Chapter 11