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Chapter 13
Stockholders’ Equity
What is a Corporation?
• A corporation is a business organized under state law
that is a separate legal entity.
• Corporations dominate business activity in the United
States.
• Most well-known companies are corporations.
• Unique characteristics of corporations:
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Separate legal entity
Number of owners
No personal liability of the owner(s)
Indefinite life
Taxation
Capital accumulation
What is a Corporation?
Corporations – Important Terms
• Authorized stock: the maximum number of shares of
stock a corporation may issue.
• Outstanding stock: stock held by the stockholders.
• Stockholders are issued stock certificates.
• Capital stock represents a stockholder’s ownership.
• Share: basic unit of stock
Stockholders’ Rights
• Vote: issues related to corporate decisions.
• Dividends: a distribution of a corporation’s earnings.
Capital Stock
• Corporations issue different classes of stock:
– Common stock
– Preferred stock
• Common stock – basic ownership of a
corporation. Every corporation issues common
stock.
• Preferred stock – given certain advantages over
common stock.
– Dividend preference – if a dividend is paid, they
receive dividends first.
– Usually do not have the right to vote.
Capital Stock
• Stock may carry a par value or may be no-par stock.
• Par value – is an amount assigned by a company to a
share of stock. Most companies set this amount very
low. There is no relation to par value and market
value.
• Stockholders’ equity: corporations equity that has
two components
– Paid-in capital: amounts received from
stockholders in exchange for stock.
– Retained earnings: equity earned by a company
and not distributed to stockholders.
Journalize the Issuance of Stock
• Companies raise capital by issuing stock.
• A company can sell its stock directly to
stockholders, or it can use the services of an
underwriter.
• The issue price is the amount a corporation
receives from issuing stock.
Issuing Common Stock at Par Value
Jan. 1 - Smart Touch Learning’s common stock carries a
par value of $1 per share, and the charter authorizes
20,000,000 shares of common stock. The stock issuance
of 15,000 shares of stock at par value is recorded as
Issuing Common Stock at a Premium
• Most of the time, stock is issued above par value.
• The issuance of stock is not considered a gain or income.
• Jan. 15 - Smart Touch Learning issues an additional 3,000
shares for $5 per share. The $4 difference between the issue
price ($5) and the par value ($1) is a premium, recorded in
Paid-in Capital in Excess of Par.
• Paid-in Capital in Excess of Par is also called additional
paid-in capital
Stockholder’s Equity on the Balance Sheet
Issuing Stock for Assets Other Than Cash
• The transaction would be recorded at the market
value of the stock issued or of the asset received,
whichever is more determinable.
• Feb. 1 - Smart Touch Learning receives furniture with
a market value of $18,000 in exchange for 5,000
shares of its $1 par common stock.
Issuing Preferred Stock
• Follows the same procedure as issuing common
stock.
• Smart Touch Learning issues 1,000 shares of its
$50 par, 6% preferred stock on January 3, 2017,
at $55 per share.
Treasury Stock
• Treasury stock is a company’s stock that it
has previously issued and later reacquired.
• Companies purchase treasury stock to:
– Increase net assets by buying low and selling
high
– Support the company’s stock price
– Avoid a takeover
– Reward valued employees with stock
Treasury Stock
• The basics of accounting for treasury stock:
– The Treasury Stock account has a normal debit
balance. Treasury Stock is a contra equity account.
– Treasury stock is recorded at cost, without
reference to par value.
– The Treasury Stock account is reported beneath
Retained Earnings on the balance sheet as a
reduction to equity.
• Treasury stock is not outstanding stock – so it is
not carry a vote and does not receive dividends.
Purchase of Treasury Stock
• On March 31, Smart Touch Learning purchased
1,000 shares of previously issued common stock,
paying $5 per share.
Sale of Treasury Stock
• If treasury stock is sold for cost – the same price the
corporation paid for it – the entry is similar to other
sales at cost
• On April 1st, sold 100 shares of treasury stock ($5 cost)
for $5 per share.
Sale of Treasury Stock
• If stock is resold for more than cost, the difference is
credited to a new account – Paid-In Capital from Treasury
Stock Transactions.
• This amount does not affect net income – it only
increases equity.
• Smart Touch Learning resold 200 of its treasury shares for
$6 per share on April 2. (Recall the cost was $5 per share.)
Sale of Treasury Stock
• The resale of treasury stock can be below the cost.
• The shortfall is debited to Paid-In Capital from
Treasury Stock Transactions.
• On April 3, Smart Touch Learning resold 200 treasury
shares for $4.30 each.
Sale of Treasury Stock
• The paid-in capital from treasury stock account cannot
fall below zero.
• If a sale of treasury stock (below cost) would make this
account have a debit balance, the difference is debited
to Retained Earnings.
• Smart Touch Learning resells an additional 200 shares
of common stock for $4.50 each. Assume they were
purchased at $5 and the balance in paid-in capital from
treasury stock is $60.
Balance Sheet with Treasury Stock Transactions
Cash Dividends
• A profitable corporation may make distributions
to stockholders in the form of dividends.
• Dividends can be paid in the form of cash, stock,
or other property.
• Three dividend dates are relevant:
– Declaration date: board of directors announces the
intention to pay dividends. A liability is created.
– Date of record: date the corporation records the
stockholders that will receive dividend checks
– Payment date: date the dividends are paid to
stockholders
Declaring and Paying Dividends
• On May 1, Smart Touch Learning declares a $0.05 per
share cash dividend on 22,700 outstanding shares of
common stock.
Declaring and Paying Dividends
• On May 15, the date of record, no journal
entry is recorded. On May 30, Smart
Touch Learning pays the dividend to its
shareholders.
Declaring and Paying Dividends – Preferred
Stock
• The dividend rate on preferred stock is expressed as a
percentage of the preferred stock par value.
• Preferred stock dividend =
Outstanding shares * par value * dividend rate
• The journal entry to record the declaration and
payment of dividends is the same as it was for common
stock .
• On Dec. 31st Smart Touch Learning declared dividends.
It has 1,000 outstanding shares of 6%, $50 par value
preferred stock.
Declaring and Paying Dividends – Preferred
Stock
Date
Account Title
12/31 Cash Dividends
Debit
3,000
Dividends Payable – Preferred
Credit
3,000
• Suppose Smart Touch Learnings declared $50,000 in
dividends. It has 1,000 outstanding shares of 6%, $50 par
value preferred stock. It also has 94,000 shares of
common stock outstanding.
Date
Account Title
12/31 Cash Dividends
Dividends Payable – Preferred
Dividends Payable – Common
Debit
50,000
Credit
3,000
47,000
How Is Equity Reported for a Corporation?
• The statement of retained earnings reports how the
company’s retained earnings balance changed from the
beginning of the period to the end of the period.
• Companies can report a negative amount in retained
earnings.
• This is called a
deficit.
Prior-Period Adjustments
• Occasionally a company may make an accounting error as
a result of mathematical mistakes or other errors not
discovered until the following period.
• Corrections to Retained Earnings for errors of an earlier
period are called prior-period adjustments.
How Do We Use Stockholders’ Equity Ratios to
Evaluate Business Performance?
• Investors are constantly comparing
companies’ profits.
• Three important ratios used for comparison
are:
– Earnings per share (EPS)
– Rate of return on common stock
– Price/earnings ratio
Earnings Per Share (EPS)
• EPS is the most widely used of all business statistics.
• EPS reports the amount of net income (loss) for
each share of the company’s outstanding common
stock.
• Formula:
(Net income – preferred dividends)
Average # of common shares outstanding
Earnings Per Share
• Green Mountain Coffee Roasters, Inc., Fiscal 2013 Annual
Report reports the following amounts:
Green Mountain Coffee Roasters, Inc., earnings per
share for 2013 is computed as follows:
Price/Earnings Ratio
• The price/earnings ratio is the ratio of the market price
of a share of common stock to the company’s earnings
per share.
• This ratio tells investors how much they should be
willing to pay for $1 of a company’s earnings.
• The higher the number – the better the return on
investment. Better to use as a comparison to other
stocks.
Rate of Return on Common Stock
• Rate of return on common stockholders’ equity,
(return on equity), shows the relationship between
net income to common stockholders and their
average common equity invested in the company.
• Most industries consider a rate of 15-20% good.