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Intermediate Accounting,17E
Equity Financing
PowerPoint presented by: Douglas Cloud
Professor Emeritus of Accounting, Pepperdine University
© 2010 Cengage Learning
13-1
13-2
Nature and Classifications
of Paid-In Capital
• A corporation is a legal artificial entity
separate from its owners.
• Individuals contribute capital for
which the corporation issues
certificates making them stockholders.
• The board of directors is elected by
the stockholders, and it is in charge of
overseeing the long-run plan for the
organization.
13-3
Common and Preferred Stock
• When a corporation is formed, a single
class of stock, known as common
stock, usually is issued.
• Corporations may later find that there
are advantages to issuing one or more
additional classes of stock with
varying rights and priorities. Stock
with certain preferences (rights) over
common stock is called preferred
stock.
13-4
Common Stock
Unless restricted by terms of the articles of
incorporation, certain basic rights are held by
each common stockholder.
1. To vote in the election of directors and in
the determination of certain corporate
policies.
2. To maintain one’s proportional interest in
the corporation through purchase of
additional common stock if and when it is
issued. This right is known as the
preemptive right.
13-5
Par or Stated Value
• Historically, par value was equal to
the market value of the shares at
issuance.
• Today, most stocks have a nominal
par value or no par value.
• No-par stock sometimes has a stated
value that for financial reporting
purposes acts like a par value.
13-6
Preferred Stock
Rights of ownership given up by
preferred stockholders:
1. Voting—in most cases, preferred
stockholders are not allowed to vote for
the board of directors
2. Sharing in success—cash dividends
received by preferred stockholders are
usually fixed in amount. If the firm
does extremely well, their dividend
amount is not adjusted
13-7
Preferred Stock
Rights enjoyed by preferred stockholders:
1. Cash dividend preference. Preferred
stockholders are entitled to receive their
full cash dividend before any cash
dividends are paid to common
stockholders.
2. Liquidation preference. In the event of
bankruptcy, preferred stockholders are
entitled to have their investments repaid
before common stockholders.
13-8
Cumulative and Noncumulative
Preferred Stock
When a corporation fails to
declare dividends on cumulative
preferred stock, such dividends
accumulate and require payment
in the future before any dividends
may be paid to common
stockholders.
13-9
Cumulative and Noncumulative
Preferred Stock
Good Time Corporation has outstanding
100,000 shares of 9% cumulative preferred
stock, $10 par. Dividends were last paid in
2008. Total dividends of $300,000 are
declared in 2011.
13-10
Cumulative and Noncumulative
Preferred Stock
• Dividends on cumulative preferred
stock that are passed are referred to
as dividends in arrears.
• With noncumulative preferred
stock, it is not necessary to provide
for passed dividends.
(continues)
13-11
Cumulative and Noncumulative
Preferred Stock
• Dividends may be declared on
common stock as long as the
noncumulative preferred stock
receives its preferred rate.
13-12
Participating Preferred Stock
Participating preferred stock
issues provide for additional
dividends to be paid to preferred
stockholders after dividends of a
specified amount are paid to the
common stockholders. A
participative provision makes
preferred stock more like common
stock.
13-13
Convertible Preferred Stock
• Preferred stock is convertible
when it can be exchanged by its
owner for some other security of
the issuing corporation.
• Conversion rights generally
provide for the exchange of
preferred stock into common
stock.
13-14
Callable Preferred Stock
• Many preferred issues are callable,
meaning they may be called and
canceled at the option of the
corporation.
• The call price is usually specified in
the original agreement and provides
for payment of dividends in arrears
as part of the repurchase price.
13-15
Redeemable Preferred Stock
• Redeemable preferred stock is
preferred stock that is redeemable at
the option of the stockholder or upon
other conditions not within the
control of the issuer.
• Redeemable preferred stock is
somewhat like a loan in that the
issuing corporation may be forced to
repay the stock proceeds.
13-16
Capital Stock Issued for Cash
• The issuance of stock for cash is
recorded by a debit to Cash and a
credit to Capital Stock for the par
value.
• When the amount of cash received for
the stock is more than the par value,
the excess is recorded as a credit to
Paid-In Capital in Excess of Par.
13-17
Capital Stock Issued for Cash
Par Value Stock
Goode Corporation issued 4,000
shares of $1 par common stock on
April 1, 2011, for $45,000 cash.
2011
Apr. 1 Cash
Common Stock
Paid-In Capital in Excess
of Par
45,000
4,000
41,000
(continues)
13-18
Capital Stock Issued for Cash
Stated Value Stock
On April 1, 2011, Goode
Corporation issued 4,000 shares of
no-par common stock with a $1
stated value.
2011
Apr. 1 Cash
Common Stock
Paid-In Capital in Excess
of Stated Value
(continues)
45,000
4,000
41,000
13-19
Capital Stock Issued for Cash
No-Par Stock
On April 1, 2011, Goode
Corporation issued 4,000 shares of
no-par common stock for $45,000
cash.
2011
Apr. 1 Cash
Common Stock
45,000
45,000
(continues)
13-20
Capital Stock Sold on
Subscription
Received subscriptions on November 1 for 5,000 shares of $1 par
common stock at $12.50 per share with 50% down, balance due in
60 days. The entries for November 1 are as follows:
Common Stock Subscriptions Receivable
Common Stock Subscribed
Paid-In Capital in Excess of Par
Cash
Common Stock Subscriptions Receivable
(continues)
62,500
5,000
57,500
31,250
31,250
13-21
Capital Stock Sold on
Subscription
On December 31, received balance due on one-half of
subscriptions and issued stock to the fully paid subscribers, 2,500
shares.
Cash
Common Stock Subscriptions Receivable
Common Stock Subscribed
Common Stock
15,625
15,625
2,500
2,500
13-22
Capital Stock Issued for
Consideration Other Than Cash
AC Company issues 200 shares of
$0.50 par value common stock in
return for land. The company’s stock is
currently selling for $50 per share.
Land
Common Stock
Paid-In Capital in Excess of Par
10,000
100
9,900
13-23
Capital Stock Issued for
Consideration Other Than Cash
The land has a readily determinable
market price of $12,000, but AC
Company’s common stock has no
established fair market value.
Land
Common Stock
Paid-In Capital in Excess of Par
12,000
100
11,900
13-24
Reasons Companies
Repurchase Stock
1. Provide shares for incentive
compensation and employee savings
plans.
2. Obtain shares needed to satisfy
requests by holders of convertible
securities.
3. Reduce the amount of equity relative
to the amount of debt.
4. Invest excess cash temporarily.
(continues)
13-25
Reasons Companies
Repurchase Stock
5. Remove some shares from the open
market in order to protect against a
hostile takeover.
6. Improve per-share earnings by reducing
the number of shares outstanding and
returning inefficiently used assets to
shareholders.
7. Display confidence that the stock is
currently undervalued by the market.
13-26
Treasury Stock
• Treasury stock is stock issued by a
corporation and subsequently reacquired
by the corporation and held for possible
future reissuance or retirement.
• Reported as a contra-equity account, not
as an asset.
• Does not create a gain or loss on
reacquisition, reissuance, or retirement.
• May decrease Retained Earnings, but
cannot increase it.
13-27
Cost Method of Accounting for
Treasury Stock
2010—Newly organized corporation issued 10,000 shares of
common stock, $1 par, at $15:
Cash
150,000
Common Stock
10,000
Paid-In Capital in Excess of Par
140,000
2011—Reacquired 1,000 shares of common stock at $40 per
share:
Treasury Stock
40,000
Cash
40,000
2011—Sold 200 shares of treasury stock at $50 per share:
Cash
Treasury Stock (200 × $40)
Paid-In Capital from Treasury Stock
10,000
Note: No gain(continues)
is recorded on sale
8,000
2,000
13-28
Cost Method of Accounting for
Treasury Stock
Because the treasury stock is reissued at a
price greater than the $40 repurchase price,
the excess is recorded in an additional paidin capital account.
2011—Sold 500 shares of treasury stock at $34 per share:
Cash
Paid-In Capital from Treasury Stock
Retained Earnings
Treasury Stock (500 × $40)
17,000
2,000
1,000
20,000
Note: No loss is recorded on sale
(continues)
13-29
Cost Method of Accounting for
Treasury Stock
Because the treasury stock is reissued at a
price less than the $40 repurchase price,
Retained Earnings is debited for the
difference; any paid-in capital from prior
treasury stock transactions may first be
debited.
2011—Retired remaining 300 shares of treasury stock:
Common Stock
Paid-In Capital in Excess of Par
Retained Earnings [300 × ($40 – $15)]
Treasury Stock (300 × $40)
300
4,200
7,500
12,000
13-30
Par (or Stated) Value Method of
Accounting for Treasury Stock
2010—Newly organized corporation issued 10,000 shares of
common stock, $1 par, at $15:
Cash
150,000
Common Stock
10,000
Paid-In Capital in Excess of Par
140,000
2011—Reacquired 1,000 shares of common stock at $40 per
share:
Treasury Stock
1,000
Paid-In Capital in Excess of Par
14,000
Retained Earnings [1,000 × ($40 – $15)]
25,000
Cash
40,000
(continues)
13-31
Par (or Stated) Value Method of
Accounting for Treasury Stock
2011—Sold 500 shares of treasury stock at $34 per share:
Cash
Treasury Stock
Paid-In Capital in Excess of Par
17,000
500
16,500
2011—Retired remaining 300 shares of treasury stock:
Common Stock
Treasury Stock
300
300
13-32
Stock Rights, Warrants,
and Options
• Stock rights—issued to existing shareholders
to permit them to maintain their proportionate
ownership interests when new shares are to be
issued.
• Stock warrants—sold by the corporation for
cash, generally in conjunction with the
issuance of another security.
• Stock options—granted to officers or
employees, usually as part of a compensation
plan.
13-33
Stock Rights
• When announcing rights to purchase
additional shares of stock, the
directors of a corporation specify a
date on which the rights will be issued.
• All stockholders of record are entitled
to the rights. Thus, between the
announcement date and the issue
date, the stock is said to sell rightson.
(continues)
13-34
Stock Rights
• After the rights are issued, the stock
sells ex-rights, and the rights may be
sold separately by those receiving
them from the corporation.
13-35
Stock Warrants
• Detachable warrants are similar to
stock rights because they can be
traded separately from the security
with which they were originally issued.
• Nondetachable warrants cannot be
separated from the security with which
they were issued.
13-36
Stock Warrants
Stewart Co. sells 1,000 shares of $50 par
preferred stock for $58 per share. Stewart
Co. gives the purchaser detachable
warrants enabling the holders to subscribe
to 1,000 shares of $2 par common stock for
$25 per share. Immediately following the
issuance of the stock, the warrants are
selling for $3, and the fair market value of a
preferred share without the warrant
attached is $57.
13-37
Stock Warrants
Value
Total
assigned to = issue
warrants
price
x
Market value of warrants
Market value
Market
of security + value of
without
warrants
warrants
Value
$3
x
assigned to = $58,000
$57 + $3
warrants
= $2,900
13-38
Stock Warrants
The entry on Stewart’s books to record the
sale of the preferred stock with detachable
warrants is:
Cash
58,000
Preferred Stock, $50 par
50,000
Paid-In Capital in Excess of Par—
Preferred Stock
5,100
Common Stock Warrants (from Slide
13-38)
2,900
13-39
Stock Warrants
If the warrants are exercised:
Common Stock Warrants
Cash
Common Stock, $2 par
Paid-In Capital in Excess of Par—
Common Stock
2,900
25,000
2,000
25,900
If the warrants expire:
Common Stock Warrants
Paid-In Capital from Expired
Warrants
2,900
2,900
13-40
Share-Based Compensation
The company estimates a grant date value of
$10 for each of the employee stock options.
The total fair value of the options granted is
$100,000. Compensation expense is allocated
over three years from January 1, 2009 (the
grant date) to January 1, 2012 (the vesting
date). The year-end entry is as follows:
2009
Dec. 31
Compensation Expense
Paid-In Capital from Stock
Options
33,333
33,333
$100,000/3
13-41
Share-Based Compensation
On December 31, 2012, all 10,000 of the options are
exercised to purchase Neff’s no-par common stock:
2012
Dec. 31 Cash (10,000 x $50)
Paid-In Capital from Stock
Options
Common Stock (no par)
500,000
100,000
600,000
If the options are allowed to expire unexercised:
2012
Dec. 31 Paid-In Capital from Stock
Options
Paid-In Capital from
Expired Options
100,000
100,000
13-42
Accounting for PerformanceBased Plans
In a performance-based stock
option plan, the plan terms are
dependent on how well the
individual or company performs
after the date the options are
granted.
13-43
Accounting for PerformanceBased Plans
• On January 1, 2009, the board of
directors of Neff Company authorized the
granting of stock options to supplement
the salaries of certain employees.
• Each stock option permits the purchase of
one share of Neff common stock at a price
of $50 per share; the market price on
January 1, 2009, is also $50 per share.
• Each option is computed to have a value
of $10.
(continues)
13-44
Accounting for PerformanceBased Plans
• The options vest, or become exercisable,
beginning on January 1, 2012, and only if
the employee stays with the company for
the entire 3-year period. The options
expire on December 31, 2012.
• The number of options granted is
contingent on Neff’s level of sales for 2011.
If Neff sales are less than $50 million, only
10,000 options will vest.
(continues)
13-45
Accounting for PerformanceBased Plans
• If Neff’s 2011 sales are between $50
million and $80 million, an additional
2,000 options will vest. If Neff’s 2011 sales
exceed $80 million, a total of 15,000
options will vest.
• Neff’s share price changed as follows over
the 3-year vesting period: Jan. 1, 2009,
$50; Dec. 31, 2009, $56; Dec. 31, 2010,
$57; Dec. 31, 2011, $59
13-46
Accounting for PerformanceBased Plans
Recognition of compensation of $40,000 for each of
the three years [(12,000 options × $10)/3]:
2009
Dec. 31
Compensation Expense
Paid-In Capital from Stock
Options
40,000
40,000
Sales are expected to be only $40 million, so only
10,000 options will vest on January 1, 2012:
2010
Dec. 31
Compensation Expense ($66,667 –
$40,000)
Paid-In Capital from Stock
Options
(continues)
26,667
26,667
13-47
Accounting for PerformanceBased Plans
Actual sales for 2011 are $85 million, so 15,000
options will vest on January 1, 2012:
2011
Dec. 31
Compensation Expense ($150,000 –
$66,667)
Paid-In Capital from Stock
Options
83,333
83,333
On December 31, 2012, all 15,000 options are
exercised to purchase Neff’s no-par common stock:
2012
Dec. 31 Cash ($15,000 × $50)
Paid-In Capital from Stock Options
Common Stock (no par)
750,000
150,000
900,000
13-48
Accounting for Awards That
Call for Cash Settlement
• Assume that Neff Company has decided
instead of granting its employees 10,000
stock options, it will grant an equal
number of cash stock appreciation
rights (SARs).
• A cash SAR awards an employee a cash
amount equal to the market value of the
issuing firm’s shares above a specified
threshold price.
13-49
Neff Company Example
• Neff’s share price:
–
–
–
–
–
January 1, 2009
December 31, 2009
December 31, 2010
December 31, 2011
December 31, 2012
$50
56
57
59
61
• As of December 31, 2009, the $56 is used
as the best estimate for the cash SARs. The
amount of cash involved will be $60,000
[10,000 × ($56 – $50)].
(continues)
13-50
Neff Company Example
2009
Dec. 31
Compensation Expense
Share-Based Compensation
Liability
20,000
20,000
At the end of 2010, the stock price is $57. The new
estimation for compensation expense is $70,000
[10,000 × ($57 – $50).
2010
Dec. 31
Compensation Expense ($46,667 –
$20,000)
Share-Based Compensation
Liability
(continues)
26,667
26,667
13-51
Neff Company Example
Neff’s stock price is $59 at the end of 2011.
Aggregate compensation expense is $90,000 [10,000
× ($59 – $50)]. Of this amount, $46,667 has already
been recognized.
2011
Dec. 31
Compensation Expense ($90,000 ─
$46,667)
Share-Based Compensation
Liability
43,333
43,333
(continues)
13-52
Neff Company Example
By the end of 2012, the price of Neff’s stock is $61.
An entry is required to reflect this increase in stock
value [10,000 × ($61 – $59).
2012
Dec. 31 Compensation Expense
Share-Based Compensation
Liability
20,000
20,000
Cash payments are made to the holders of the
10,000 SARs on December 31, 2012.
2012
Dec. 31 Share-Based Compensation Liability
Cash [10,000 × ($61 – $50)]
110,000
110,000
13-53
Mandatorily Redeemable
Preferred Shares
• Historically, the SEC required that
firms not include mandatorily
redeemable preferred stock under the
Stockholders’ Equity heading.
• Given a “mezzanine” treatment.
• FASB Statement No. 150 requires
these items to be reported as liabilities
in the balance sheet.
13-54
Written Put Options
• A put option is an agreement that
allows investors to sell the issuing
corporation shares they hold at set
prices on specific dates.
• If the stock price stays above a set
level per share, the issuing
corporation pays nothing.
• Historically recorded as part of equity.
(continues)
13-55
Written Put Options
• In Statement No.150, the FASB
instructs companies to record the fair
value of the obligation under written
put options on a company’s own
shares as a liability.
13-56
Obligation to Issue Shares of a
Certain Dollar Value
• Companies occasionally agree to satisfy
their obligations by delivering shares of
their own stock rather than by paying
cash.
• This is especially true for startup
companies.
• Can be recorded as equity or as a
liability, depending on how the contract
is written.
13-57
Noncontrolling Interest
• When a parent company owns less than
100% of the subsidiary’s assets and
liabilities, there are minority
stockholders.
• Financing provided by minority
stockholders is called minority
interest.
• Under SFAS No. 160, the FASB uses
the term noncontrolling interest.
13-58
Stock Conversions
Case 1
On December 31, 2011, 1,000 shares of preferred
stock (par $50) are exchanged for 4,000 shares of
common stock (par $1).
2011
Dec. 31
Preferred Stock, $50 par
Paid-In Capital in Excess of Par—
Preferred
Common Stock, $1 par
Paid-In Capital in Excess of
Par—Common
50,000
10,000
4,000
56,000
13-59
Stock Conversions
Case 2
On December 31, 2011, 1,000 shares of preferred
stock (par $50) are exchanged for 4,000 shares of
common stock (par $20).
2011
Dec. 31 Preferred Stock, $50 par
Paid-In Capital in Excess of Par—
Preferred
Retained Earnings
Common Stock, $20 par
50,000
10,000
20,000
80,000
13-60
Factors Affecting
Retained Earnings
13-61
Net Income and Dividends
• The primary source of retained earnings is
the net income generated by a business.
• When operating losses or other debits to
Retained Earnings produce a debit balance
in the account, the debit balance is referred
to as a deficit.
• Use of the term dividends without
qualification normally implies the
distribution of cash.
13-62
Prior-Period Adjustments
In some situations, errors made
in past years are discovered and
corrected in the current year by
an adjustment to Retained
Earnings, referred to as a priorperiod adjustment.
13-63
Accounting for Dividends
In setting dividend policy, the board
of directors must answer two
questions:
1. Do we have the legal right to declare a
dividend?
2. Is a dividend distribution financially
advisable?
13-64
Accounting for Dividends
• Declaration date—date the corporation’s
board of directors formally declares a
dividend will be paid
• Date of record—date on which
stockholders of record are identified as
those who will receive a dividend
• Date of payment—date when the dividend
is actually distributed to stockholders
13-65
Cash Dividends
ABC Corporation declares a $100,000
dividend; the following journal entries
should be made:
Declaration of Dividend:
Dividends (or Retained Earnings)
Dividends Payable
100,000
Payment of Dividend:
Dividends Payable
Cash
100,000
100,000
100,000
13-66
Property Dividends
• A property dividend is a distribution to
stockholders that is payable in some asset
other than cash.
• Bigler Corporation owns 100,000 shares in
Tri-State Oil Co, carrying value $2,700,000,
current market value $3,000,000, or $30
per share. There are 1,000,000 shares of
Bigler stock outstanding. A dividend of 1/10
of a share of Tri-State Oil Co. is declared for
each share of Bigler stock outstanding.
13-67
Property Dividends
Declaration of Dividend:
Dividends (or Retained Earnings)
Property Dividends Payable
Gain on Distribution of Property
Dividends
3,000,000
2,700,000
300,000
Payment of Dividend:
Property Dividends Payable
Investment in Tri-State Oil Co. Stock
2,700,000
2,700,000
13-68
Stock Dividends
• Small:
– Less than 20–25% of the outstanding
shares.
– Debit Retained Earnings for the market
value of the shares.
• Large:
– Greater than 20–25% of the shares
outstanding.
– Debit Retained Earnings for the par value
of the shares.
13-69
Small Dividend Example
The stockholders’ equity section for the Fuji
Company on July 1 is as follows:
Common Stock, $1 par, 100,000
shares outstanding
Paid-In Capital in Excess of Par
Retained Earnings
$ 100,000
1,100,000
750,000
The company declares a 10% stock dividend.
Before the stock dividend, the stock is selling for
$22 per share. After the stock dividend, each
original share sells for $20.
(continues)
13-70
Small Dividend Example
Declaration of Dividend:
Retained Earnings
Stock Dividends Distributable
Paid-In Capital in Excess of Par
200,000
10,000
190,000
Payment of Dividend:
Stock Dividends Distributable
Common Stock, $1 par
10,000
10,000
13-71
Large Dividend Example
The stockholders’ equity section for the Fuji
Company on July 1 is as follows:
Common Stock, $1 par, 100,000
shares outstanding
Paid-In Capital in Excess of Par
Retained Earnings
$ 100,000
1,100,000
750,000
The company declares a 50% stock dividend.
Before the stock dividend, the stock is selling for
$22 per share.
(continues)
13-72
Large Dividend Example
Declaration of Dividend:
Retained Earnings
Stock Dividends Distributable
OR
Paid-In Capital in Excess of Par
Stock Dividends Distributable
50,000
50,000
50,000
50,000
Payment of Dividend:
Stock Dividends Distributable
Common Stock, $1 par
50,000
50,000
13-73
Stock Dividends versus
Stock Splits
• A corporation may effect a stock split by
reducing the par or stated value of each
share of capital stock and proportionately
increasing the number of shares outstanding.
• A stock dividend results in an increase in the
number of shares outstanding. The par or
stated value remains unchanged.
• A stock split divides the existing Capital
Stock balance into more parts, with a
reduction in par or stated value of each
share.
13-74
Liquidating Dividends
• A liquidating dividend is a
distribution representing a return to
stockholders of a portion of
contribution capital.
• Example: Stubbs Corporation
declared and paid a cash dividend
($10 cash dividend) totaling $100,000
and a partial liquidating dividend of
$50,000.
13-75
Foreign Currency
Translation Adjustment
• The foreign currency translation
adjustment arises from the change in
the equity of foreign subsidiaries (as
measured in terms of U.S. dollars)
that occurs as a result of changes in
foreign currency exchange rates.
• These changes are recorded as direct
adjustments to equity.
13-76
Unrealized Gains and Losses on
Available-for-Sale Securities
• Available-for-sale securities are
those that were not purchased with
immediate intention to resell, but
that a company also doesn’t
necessarily plan to hold forever.
• Reported on the balance sheet at
their current market value.
13-77
Unrealized Gains and Losses
on Derivatives
• A derivative is a financial instrument,
such as an option or a future, that
derives its value from the movement of a
price, an exchange rate, or an interest
rate associated with some other item.
• Derivatives are used to manage risk
associated with sales or purchases that
will not occur until a future period.
13-78
International Accounting:
Equity Reserves
• In foreign countries, the payment of
cash dividends is linked to the
amount of distributable equity.
• Equity is divided among various
equity reserve accounts, each with
legal restrictions dictating whether
it can be distributed to
stockholders.
13-79
International Accounting
• Capital stock may be:
 Authorized but unissued
 Subscribed for and held for issuance
pending receipt of cash for the full
amount of the subscription price
 Outstanding in the hands of stockholders
 Reacquired and held by the corporation
for subsequent reissuance
 Canceled by appropriate corporate action
13-80