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Cornerstones of Financial Accounting
Chapter 10
Learning Objectives
LO1. Describe the different elements of stockholders’ equity and prepare the
stockholders’ equity section of the balance sheet.
There are various elements of equity and the stockholders’ equity section of
the balance sheet clearly classifies these elements according to their source:
capital stock—split between preferred and common stock and associated
paid-in capital in excess of par;
retained earnings or deficit;
accumulated other comprehensive income; and
treasury stock.
Corporations split their stockholders’ equity into these sections, although most
corporations do not have all of these elements.
LO2. Distinguish between the different forms of equity and describe their use in
raising capital.
Corporations sell both common stock and preferred stock to raise capital.
Preferred stock generally guarantees a regular dividend and receives priority
over common stock in the payment of dividends and distribution of assets in
Common stock has voting rights and receives all benefits not assigned to the
preferred stockholders or creditors.
Selling different classes of stock (with different features) attracts shareholders
with diverse risk preferences and tax situations.
LO3. Record the issuance of capital stock.
Both preferred and common stock are generally recorded at par or stated
Any extra consideration received is recorded as “paid-in capital in excess of
LO4. Account for the distribution of assets to stockholders.
Assets are distributed to stockholders by:
repurchasing their shares of stock, or
paying dividends.
Generally the cost of stock repurchases are recorded as a reduction in stock
holders’ equity (a debit to “treasury stock”).
Typically the corporation pays dividends with cash.
Stock dividends and stock splits do not represent a payout to stockholders.
These transactions have no effect on total stockholders’ equity.
Preferred stock generally has dividend preferences such as being cumulative
or participating.
LO5. Describe the accounting issues related to retained earnings and accumulated
other comprehensive income.
Retained earnings represents the earnings that the corporation elects not to pay
out in dividends.
Ending retained earnings is calculated by adding net income and subtracting
dividends to beginning retained earnings.
Retained earnings can be restricted, which communicates to stockholders that
this portion of retained earnings is not eligible for dividend payout.
LO6. Analyze stockholder payout and profitability ratios using information
contained in the stockholders’ equity section.
Stockholders are primarily interested in two things:
the creation of value, and
the distribution of value.
Analysis of the stockholders’ equity section of the balance sheet in
conjunction with the statement of stockholders’ equity allows stockholders
to separate these concepts.