Download Chapter 15 Glossary

Glossary—Chapter 15
additional paid-in capital Any excess over par value paid in by stockholders in return for the shares issued
to them. Once paid in, the excess over par becomes a part of the corporation’s additional paid-in capital.
Also called paid-in capital in excess of par. (p. 745).
book value per share The amount each share of stock would receive if a company were liquidated, based
on the amounts reported on the balance sheet. Computed as common stockholders’ equity divided by the
number of outstanding shares of stock. If the valuations on the balance sheet do not approximate the market
value of the shares, the book value per share figure loses its relevance. (p. 768).
callable preferred stock Preferred stock that permits the corporation, at its option, to call or redeem the
outstanding preferred shares at specified future dates and stipulated prices. The callable feature enables the
company to use the capital from the issuance of the preferred stock until the need has passed or it is no
longer advantageous. (p. 755).
cash dividends Pro rata distributions of cash to a company’s stockholders as of a certain date (date of
declaration), as approved by the company’s board of directors. A company may declare dividends either as
a certain percent of par or as an amount per share. A declared cash dividend is a current liability of the
company between the date of declaration and the payment date. Companies do not declare or pay cash
dividends on treasury stock. (p. 758).
common stock The basic ownership interest in a corporation, as evidenced by shares that represent
proportional ownership. Holders of common stock bear the ultimate risks of loss (they are guaranteed
neither dividends nor assets upon dissolution) and receive the benefits of success through distributions of
dividends or sales at a gain. They also generally control the management of the corporation through voting
rights. If a corporation has only one authorized issue of capital stock, that issue is by definition common
stock. (p. 743).
contributed (paid-in) capital The total amount paid in on capital stock—the amount provided by
stockholders to the corporation for use in the business. Contributed capital includes the par value of all
outstanding stock plus additional paid-in capital (any excess over par value paid in by stockholders). (p.
744).
convertible preferred stock Preferred stock that allows stockholders, at their option, to exchange preferred
shares for shares of common stock at a predetermined ratio. The convertible preferred stockholder not only
enjoys a preferred claim on dividends but also has the option of converting into a common stockholder with
unlimited participation in earnings. (p. 755).
cost method A method of accounting for treasury stock, in which a company debits a Treasury Stock
account for the cost of reacquiring stock to be held in the treasury and reports this account as a deduction
from “total paid-in capital and retained earnings” on the balance sheet. (p. 751).
cumulative preferred stock Cumulative preferred stock constitutes a dividend in arrears. A corporation
does not record a dividend in arrears as a liability (because no liability exists until the board of directors
declares a dividend), but discloses it in a note to the financial statements. (p. 754).
dividend in arrears A dividend on cumulative preferred stock that a company’s board of directors fails to
declare at the normal date for dividend action. Such a dividend is said to have been “passed.” The
corporation must make up the passed dividend in a later year before it can pay any dividends to common
stockholders. (p. 754).
earned capital The capital that develops from a company’s profitable operations. It consists of all
undistributed income that remains invested in the company. Earned capital is differentiated from
contributed (paid-in) capital that comes from stockholders’ purchase of capital stock. (p. 744).
large stock dividend A stock dividend (a corporation’s issuance of its own stock to its stockholders, on a
pro rata basis) of more than 20–25 percent of the number of shares previously outstanding. The company
transfers, from retained earnings to capital stock, the par value of the stock issued. Such a distribution
(often referred to as a split-up effected in the form of a stock dividend) typically reduces the market price of
the stock, making it more marketable. The effects of large stock dividends thus make them more like stock
splits than like an ordinary stock dividend. (p. 763).
leveraged buyout (LBO) Transaction in which a company borrows money to finance the repurchase of all
of the company’s outstanding stock, in order to eliminate public (outside) ownership. (p. 750).
liquidating dividends Dividends based on amounts other than retained earnings, implying that the
dividends are a return of the stockholder’s investment rather than of profits. Any dividend not based on
earnings reduces corporate paid-in capital. (pp. 758, 760).
lump-sum sales The issuance of two or more classes of securities for a single payment (lump sum).
Companies use one of two methods of allocating the proceeds among the multiple classes of securities: the
proportional method (allocate among classes on a proportional basis) or the incremental method (allocate
using market value of securities for which market value is known and allocate the remainder to the class for
which market value is not known). (p. 746).
no-par stock Capital stock that has not been assigned a par value. No-par stock avoids the contingent
liability that might occur if the corporation issued par value stock at a discount and avoids the possibility of
mistakenly using par value as a basis for fair value. (p. 745).
par (stated) value method A method of accounting for treasury stock, in which a company records all
transactions in treasury shares at their par value and reports the treasury stock as a deduction from capital
stock only. (p. 751).
participating preferred stock Preferred stock whose holders share ratably with the common stockholders
in any profit distributions beyond the prescribed rate. Its holders receive the prescribed return for preferred
stock plus dividends generally at the same rates as those paid to common stockholders if the company pays
dividends on common stock in excess of the prescribed preferred rate. (p. 754).
payout ratio Profitability ratio that measures the percentage of earnings a company distributes to common
stockholders in the form of cash dividends. Computed as cash dividends paid to common stockholders
divided by net income available to common stockholders (net income minus preferred dividends). (p. 767).
Glossary, Chapter 15 (cont’d.)
preemptive right The right of shareholders (unless prohibited in articles of incorporation) to share
proportionately in any new issues of stock of the same class. The preemptive right protects existing
stockholders from involuntary dilution of ownership interest when a corporation issues additional stock.
Stock warrants (an option to purchase stock) are commonly used to satisfy this right. (p. 743).
preferred stock A special class of stock that gives its holders certain special preference or features not
possessed by common stock. Holders typically get preference as to dividends and to assets in the event of
liquidation, and the preferred stock may be convertible into common stock or callable at the option of the
corporation. The preferred stockholder may sacrifice certain rights in return for the other special rights and
privileges; preferred stock may be nonvoting, noncumulative, and nonparticipating. The accounting for
preferred stock is similar to that for common stock, with preferred stock classified in a separate category in
stockholders’ equity. (p. 743).
property dividends Dividends payable in assets of the corporation other than cash. Also called dividends
in kind. Property dividends may be merchandise, real estate, or investments. The company restates at fair
value the property it will distribute, recognizing any gain or loss on the difference between the property’s
fair value and carrying value, and records the dividend in either the retained earnings account or a property
dividends account. (p. 759).
rate of return on common stock equity Profitability ratio that indicates how many dollars of net income
the company earned for each dollar invested by the common stockholders. Also called return on equity
(ROE). Computed as net income less preferred dividends divided by average common stockholders’ equity.
(p. 767).
redeemable preferred stock Preferred stock that has a mandatory redemption period or a redemption
feature that the issuer cannot control, making the security more like debt than like an equity instrument.
The FASB requires that these (and similar) debt-like securities be classified and accounted for as liabilities.
(p. 755).
residual interest The difference between the assets and the liabilities of the company, which represents the
owners’ or stockholders’ interest in the company. The concept of residual interest means that stockholders’
equity has no existence apart from the assets and liabilities of the company—that stockholders’ equity is
not a claim to specific assets but a claim against the assets remaining after financial obligations have been
met. (p. 744).
retained earnings The earned capital of the company, which develops from profitable operations. It
consists of all undistributed income that remains invested in the company. (p. 744).
small (ordinary) stock dividend A stock dividend (a corporation’s issuance of its own stock to its
stockholders, on a pro rata basis) of less than 20–25 percent of the number of shares previously
outstanding. The company transfers, from retained earnings to capital stock and additional paid-in capital,
the fair market value of the stock issued. Payment of the stock dividend does not affect any asset or
liability, but is a reclassification of stockholders’ equity. (p. 691).
stated value A value below which a company cannot issue no-par stock, as required by law in some states.
Stated-value stock thus becomes, in effect, stock with a par value. (p. 761).
stated value See par (stated) value method. (p. 746).
statement of stockholders’ equity One of the basic financial statements, which reports the changes in each
stockholders’ equity account and in total stockholders’ equity during the year. It typically shows balances
at the beginning of the period, additions and deductions, and balances at the end of the period. Companies
disclose changes in the separate accounts either in separate statements or in the basic financial statements
or notes thereto. (p. 766).
stock dividends The issuance by a corporation of its own stock to its stockholders on a pro rata basis,
without receiving any consideration. The company transfers, from retained earnings to capital stock and
additional paid-in capital, the fair market value of the stock issued. Payment of the stock dividend does not
affect any asset or liability, but is a reclassification of stockholders’ equity. The term stock dividend usually
refers to what are properly classified as small (ordinary) stock dividends. (In contrast, large stock dividends
are more like stock splits because of their effect of the market price of the stock.) (p. 760).
stock split The issuance of additional shares of stock by dividing existing shares into multiple shares for
each share owned; e.g., a 4-for-1 split gives a shareholder 4 shares for each 1 share owned. The motive is to
reduce the market price of shares to be within range of the majority of potential investors. Companies
record no entry for a stock split, but make a memorandum note to indicate the changed par value and the
increased number of shares. (p. 762).
stockholders’ (owners’) equity The ownership claim on a company’s total assets, computed as the
difference between a company’s assets and its liabilities. Stockholders’ equity represents the cumulative net
contributions by stockholders plus retained earnings. Reported in the stockholders’ (owners’) equity section
of the corporate balance sheet, stockholders’ equity consists of capital stock, additional paid-in capital, and
retained earnings. (p. 744).
trading on the equity The practice of using borrowed money or issuing preferred stock in hope of
obtaining a higher rate of return on the money used. If return on the assets is higher than the cost of
financing these assets, the excess accrues as a profit to the common stockholders. (p. 767).
treasury stock Shares of stock reacquired by the issuing company and either retired or held in the treasury
for reissue at a later date. Treasury stock is essentially the same as unissued capital stock; it is not an asset.
Companies use two methods of accounting for treasury stock: the cost method (which records the purchase
in a treasury stock account and reports that amount as a deduction from “paid-in capital and retained
earnings” on the balance sheet), or the par-value method (which records all transactions in treasury shares
at their par value and reports the treasury stock as a deduction from capital stock only). Companies
generally use the cost method to account for treasury stock. (p. 750).