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Chapter 10
Stockholders’ Equity
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
Stockholders’ Equity
Stockholders’ Equity = Assets - Liabilities
Primary Sections of Stockholders’ Equity
Paid-in capital
Retained Earnings
Treasury Stock
Amount
stockholders have
invested in the
corporation
Amount of earnings
the corporation has
retained
Corporation’s own
stock that it has
reacquired
10-2
Part A
Invested Capital
10-3
LO1 Corporations
o Articles of incorporation (or corporate
charter) describe
a) the nature of the firm’s business activities
b) the shares to be issued
c) the initial board of directors
o Corporation’s stockholders control the
corporation - By voting their shares, they
determine the makeup of the board of directors
- which in turn appoints the management to run
the corporation.
10-4
Stages of Equity Financing
o The progression leading to a public offering might
include some or all of these steps:
o Investment by the founders of the business.
o Investment by friends and family of the founders.
o Outside investment by “angel” investors (wealthy
individuals in the business community willing to
provide investment funds) and venture capital firms
(provide additional financing for a percentage
ownership in the corporation).
o Initial public offering (IPO), the first time a
corporation issues stock to the public.
10-5
Public or Private
Corporations may be either public or private
Public



Stocks trade on a stock
exchanges such as NYSE,
AMEX, NASDAQ; or by
over-the-counter (OTC)
trading.
Regulated by the
Securities and Exchange
Commission (SEC)
Examples – Wal-Mart,
Microsoft, Intel
Private



Does not allow investment
by the general public and
has fewer stockholders
Not regulated by the
Securities and Exchange
Commission (SEC) and do
not need to file financial
statements with it
Examples - Cargill
(agricultural commodities)
Koch Industries (oil and
gas), Chrysler (cars)
10-6
Stockholder Rights

Whether public or private, stockholders
are the owners of the corporation and
have certain rights:
o
o
o
o
Right to vote
Right to receive dividends
Right to share in distribution of assets
Preemptive right – allows a stockholder to
maintain his or her percentage share of
ownership.
10-7
Advantages and Disadvantages of a
Corporation
Disadvantages
Advantages

Limited liability

Additional taxes

Ability to raise capital

More paperwork

Lack of mutual agency
10-8
LO2 Common Stock
o If a corporation has only one kind of stock, it
usually is labeled as common stock.
Type of Stock
Authorized
Definition
Shares available to sell
(issued and unissued)
Issued
Shares actually sold
(includes treasury stock)
Outstanding
Shares held by investors
(excludes treasury stock)
Authorized – Unissued = Issued
Issued – Treasury Stock = Outstanding
10-9
Par Value
o
The legal capital per share of stock that’s assigned
when the corporation is first established
Has no significant meaning
today.
Has no relationship to the
market value of the common
stock
NO PAR VALUE
STATED VALUE
Common stock that has not
been assigned a par value
Treated in the same manner as
par value shares
10-10
Accounting for Common Stock Issues
When a corporation receives cash from issuing common stock, it
debits cash. If it issues no-par value stock, the corporation credits
the equity account entitled common stock.
Cash (1,000 shares x $30)
30,000
Common Stock
30,000
(Issue no-par value common stock)
The entry changes slightly if the corporation issues par value stock
rather than no-par value stock. In that case, we credit common
stock and additional paid-in capital.
Cash (1,000 shares x $30)
30,000
Common Stock (1,000 shares x $0.01)
10
Additional Paid-in Capital (difference)
29,990
(Issue common stock above par)
10-11
LO3 Preferred Stock


Usually have first rights to a specified amount of Dividends.
Receive preference over common stockholders in the
distribution of assets in the event the corporation is dissolved.
Comparison of common stock, preferred stock, and bonds
Common
Stock
Preferred
Stock
Bonds
Yes
Usually No
No
Risk to the investor
Highest
Middle
Lowest
Expected return to the investor
Highest
Middle
Lowest
Risk of contract violations
Lowest
Middle
Highest
Preference for payments
Lowest
Middle
Highest
No
Usually No
Yes
Factor
Voting rights
Tax deductibility of payments
10-12
Accounting for Preferred Stock Issues
The entries to record the issuance of preferred stock
are similar to those for the issue of common stock
Cash (1,000 shares x $40)
40,000
Preferred Stock (1,000 shares x $30)
30,000
Additional Paid-in Capital
10,000
(Issue preferred stock above par)
10-13
Features of Preferred Stock
Flexibility allowed in its contractual provisions
Convertible
Shares can be
exchanged for
common stock
Redeemable
Shares can be
returned to the
corporation at a
fixed price
Cumulative
Shares receive
priority for future
dividends, if
dividends are not
paid in a given year
10-14
LO4 Treasury Stock
A corporation’s own stock that it has reacquired

Why corporations repurchase their stock




To boost under-priced stock.
To distribute surplus cash without paying
dividends.
To boost earnings per share.
To offset issuance of shares under stockbased compensation plans.
10-15
Accounting for Treasury Stock
o
o
Treasury stock is reported as a contra-equity (negative
equity account).
When a corporation repurchases its own stock, it increases,
or debits treasury stock and vice versa when it sells.
Treasury Stock (100 shares x $30)
Reissue
price
3,000
Cash
3,000
(Repurchase treasury stock)
Cash (100 shares x $35)
Treasury Stock (100 shares x $30)
3,500
3,000
Additional Paid-in Capital (difference)
(Reissue treasury stock above cost)
500
Cost
10-16
Accounting for Treasury Stock
What if the stock price goes down and we reissue the
treasury stock for less than we paid to buy back the shares?
Reissue
price
Cash (100 x $25)
Additional Paid-in Capital (100 x $5)
2,500
500
Treasury Stock (100 x $30)
3,000
(Sell treasury stock below cost)
Cost
10-17
Part B
Earned Capital
10-18
LO5 Retained Earnings and Dividends
RETAINED EARNINGS
o
o
o
o
Represents the earnings retained in the
corporation – earnings not paid out as dividends to
stockholders.
Equals all net income, less all dividends, since the
corporation began.
Has a normal credit balance consistent with other
stockholders’ equity accounts.
If losses exceed income since the corporation
began, retained earnings will have a debit balance
and is called an accumulated deficit.
10-19
Dividends
Distributions by a corporation to its stockholders
Not paid on treasury shares
repurchased by the
corporation
Investors pay careful attention
to cash dividends
DECLARATION DATE
Date on which dividend is
declared
RECORD DATE
PAYMENT DATE
Date on which the registered
owners of stock are
determined
Date on which the cash
dividend is paid
10-20
Dividends
Lets consider the following dividend example
A corporation declares a $0.25 per share dividend on its 2,000
outstanding shares
March 15 (declaration date)
Retained Earnings (2,000 shares x $0.25)
500
Dividends Payable
500
(Declaration of cash dividends)
March 31 (No entry for Record date)
April 15 (payment date)
Dividends Payable (2,000 shares x $0.25)
Cash
500
500
(Payment of cash dividends)
10-21
LO6 Stock Dividends and Stock Splits
Sometimes, corporations distribute to shareholders additional
shares of the companies’ own stock rather than cash. These
are known as stock dividends or stock splits depending on
the size of the stock distribution.
You own 100 shares
and assume a
You will get
10% stock dividend
10 additional shares
20% stock dividend
20 additional shares
100% stock dividend
100 additional shares
Large stock dividend
or stock split (2-for-1)
Small stock
dividend
10-22
Stock Dividends
Since the corporation’s shares double following a 100% stock
dividend, we make an entry to reflect the increase in the par
value of the common shares.
Retained Earnings (1,000 shares x $0.01)
10
Common Stock
10
(100% stock dividend, large stock dividend)
Small stock dividends are recorded by debiting retained
earnings for the market value, rather than the par value, per
share.
Retained Earnings (1,000 x 10% x $30)
3,000
Common Stock (1,000 x 10% x $0.01)
1
Additional Paid-In Capital (difference)
2,999
(10% stock dividend, small stock dividend)
10-23
Stock Splits
o
o
o
o
A stock distribution of 25% or higher, although it’s
technically a “large” stock dividend, is more often
referred to as a stock split.
A 100% stock dividend is effectively the same as a
2-for-1 stock split, although the accounting for a
100% stock dividend and a 2-for-1 stock split
differs.
Make no journal entry to record a stock split.
After a 2-for-1 stock split, the common stock
account balance (total par) represents twice as
many shares and the par value per share is
reduced by one-half.
10-24
Part C
Reporting and Analyzing
Stockholders’ Equity
10-25
LO7 Stockholders’ Equity
AMERICAN EAGLE
Balance Sheet (partial)
January 31, 2009
($’s and number of shares in thousands)
Total assets
Total liabilities
Stockholders’ equity:
Preferred stock, $0.01 par value
Common stock, $0.01 par value
Additional paid-in capital
Total paid-in capital
Retained earnings
Less: Treasury stock, 43,248 (thousand) shares
Total stockholders’ equity
Total liabilities and stockholders’ equity
$1,963,676
$554,645
2,485
513,574
516,059
1,679,772
(786,800)
$1,409,031
$1,963,676
10-26
Statement of Stockholders’ Equity
Summarizes the changes in the balance in each
stockholders’ equity account over a period of time.
CANADIAN FALCON
Statement of Stockholders’ Equity
For the year ended December 31, 2012
Total
Additional
Preferred Common Paid-in Retained Treasury Stockholders’
Equity
Stock
Capital Earnings
Stock
Stock
Balance, January 1
Issued common stock
Issued preferred stock
Repurchase of
treasury stock
Sale of treasury stock
Cash dividends
100% stock dividend
Net income
Balance, December 31
0
0
$10
$30,000
0
$29,990
10,000
0
($3,000)
3,000
500
10
$30,000
$20
$40,490
0
($500)
(10)
30,000
$29,490
$0
0
$30,000
40,000
(3,000)
3,500
(500)
0
30,000
$100,000
10-27
LO8 Equity Analysis
Equity Analysis
Return on
Equity
Return on the Market
Value of Equity
Price-Earnings
Ratio
Earnings Per
Share
10-28
Return on Equity
Measures the ability of company management to
generate earnings from the resources that owners
provide.
Return on
equity
Net income
=
Average stockholders’
equity
10-29
Return on Market Value of Equity
To supplement the return on equity ratio, analysts
often relate earnings to the market value of equity
calculated as the ending stock price times the
number of shares outstanding.
Return on the
market value of
equity
Net income
=
Market value of equity
10-30
Earnings Per Share
o Measures the net income earned per share of common
stock.
o Useful in evaluating the earnings performance of a
company over time.
o Not useful in comparing earnings performance across
companies.
Net income
Earnings per share
=
Average shares outstanding
during the period
10-31
Price-Earnings Ratio (PE Ratio)
o A high PE ratio indicates investors expect future earnings
to be higher.
o A low PE ratio indicates investors lack of confidence in
future earnings growth.
Stock price
Price-Earnings
Ratio
=
Earnings per share
GROWTH STOCKS
VALUE STOCKS
Priced high in relation to
current earnings
Priced low in relation to
current earnings
10-32
End of chapter 10
10-33