Download Preferred stock

INTERMEDIATE
ACCOUNTING
Chapter 15
Contributed Capital
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Learning Objectives
1. Define equity and explain the corporate form of organization,
including its advantages and disadvantages.
2. Know the rights and terms that apply to capital stock.
3. Account for the issuance of capital stock.
4. Describe noncompensatory share purchase plans.
5. Describe and account for share-based compensation plans.
6. Describe the characteristics of preferred stock.
7. Understand the accounting for treasury stock.
8. Know the components of contributed capital and how they are
reported in financial statements.
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Shareholders’ Equity
Learning Objective #1
Equity is the residual interest in the assets of a company that
remains after deducting its liabilities.
 The balance sheet accounting for financing activities by common
equity shareholders typically involves:
 Contributed capital accounts, such as common equity at par
and additional paid-in capital
 Earned capital accounts, such as retained earnings and
accumulated other comprehensive income
 Contributed Capital is the section of shareholders’ equity in
which a corporation records the results of all its stock
transactions in capital stock accounts and additional paid-in
capital accounts.

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What Information Does
Shareholders’ Equity Provide?
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(Slide 2 of 2)
Contributed Capital is the section of shareholders’ equity in which a
corporation records the results of all its stock transactions in capital
stock accounts and additional paid-in capital accounts.
Retained Earnings is an account in shareholders’ equity where any
net income that has been reinvested in the corporation and not paid
out to shareholders as dividends is reported.
Accumulated Other Comprehensive Income is an account in
shareholders’ equity where a corporation reports any increase or
decrease in shareholders’ equity as a result of other comprehensive
income.
A company’s equity changes:
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As it earns net income
As it declares dividends
As transactions between the company and its owners occur
As other comprehensive income transactions occur
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Changes in Equity Accounts
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How Are Corporations Organized?
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Shareholders (or stockholders) are owners of a corporation.
The primary advantage of the corporate form is the ability to
raise large amounts of capital by issuing shares of stock.
Limited legal liability is a concept in which owners bear no
personal liability for the corporation’s debts and risk; they risk
only their capital investment.
Corporations generally pay more taxes than other
organization forms because of:
 Higher tax rates than other forms
 Owners are subject to double taxation
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Income earned by the corporation
Dividends distributed to shareholders
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
How Are Corporations Classified?
(Slide 1 of 2)
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Stock companies issue shares of stock to shareholders and
operate for profit:
 Open corporations (often called publicly traded
corporations) are corporations whose stock can be
purchased by any individual on a stock exchange.
 Closed corporations (often called privately held
corporations) are corporations that do not allow the sale
of stock to the general public; some are family owned and
shares are not available for purchase by the public.
Public corporations are owned by governmental units.
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How Are Corporations Classified?
(Slide 2 of 2)
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Domestic corporations are companies doing business in the
state or country in which they are incorporated.
 Starbucks, which is incorporated in the State of Washington,
is a domestic company with respect to Washington.
 Volkswagen is a domestic company of Germany.
Foreign corporations are companies that are operated in a
state or nation other than the one in which it is incorporated.
 Starbucks is a foreign corporation with regard to the State
of North Carolina.
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
How Are Corporations Formed?
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In the United States, a corporation is a legal entity of a
particular state.
An approved application for incorporation becomes a
corporation’s articles of incorporation (or corporate charter).
For a corporation to perform its functions, the state gives it
various rights and powers. These include the right to:
 Enter into contracts
 Hold, buy, and sell property
 Sue and be sued
 Continue indefinitely
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Capital Structure of a Corporation
Learning Objective #2
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A stock certificate is a serially numbered document that
indicates the number of shares owned and the par value (if
any).
 Because stock certificates are easily transferred from one
investor to another, state laws require that each
corporation keep appropriate records of its shareholders.
A transfer agent (such as a bank) handles the issuance of stock
certificates.
A registrar maintains the shareholder records.
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Capital Stock and Shareholders’ Rights
(Slide 1 of 2)
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Capital stock refers to the shares of stock issued by the
corporation and owned by its shareholders.
Each shareholder has various rights.
 Right to a dividend when it is declared
 Right to elect directors and to establish corporate policies
(voting right)
 Right (called a preemptive right) to maintain a
proportionate interest in the ownership of the corporation
by purchasing a proportionate (pro rata) share of
additional capital stock if more stock is issued
 Right to share in the distribution of the assets of the
corporation if it is liquidated
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Capital Stock and Shareholders’ Rights
(Slide 2 of 2)
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Common stock is capital stock that carries all of the rights of
ownership.
 Some corporations issue more than one class of common
stock such as Class A and Class B common stock.
 In this case, usually one type of common stock has greater
voting rights than the other to maintain control over the
corporate activities.
Preferred stock is not granted all of the common stock’s rights,
but receives in exchange certain other privileges.
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Basic Terminology
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Authorized capital stock is the number of shares of capital stock
that a corporation may issue as stated in the corporate charter.
Issued capital stock is the number of shares of capital stock that a
corporation has issued to its shareholders as of a specific date.
Outstanding capital stock is the number of shares of capital stock
that a corporation issued to shareholders and that are being held
by shareholders as of a specific date.
Treasury stock is the number of shares of capital stock issued to
and reacquired from shareholders but not retired.
Subscribed capital stock is the number of shares of capital stock
that a corporation will issue upon completion of an installment
purchase contract with an investor.
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Legal Capital

To protect the corporation’s creditors, state laws have
established the concept of legal capital as the amount of
stockholders’ equity that the corporation cannot distribute to
shareholders.
 The definition of legal capital varies among states;
 In most states, the par value or stated value of all its issued
stock is the legal capital.
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Par Value and Stated Value
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The par value of a corporation’s capital stock (either common or
preferred) is a designated dollar amount per share that is
established in the articles of incorporation and is printed on each
stock certificate.
 The par value of a stock has no relation to its market value.
 Stock rarely sells initially for less than its par value, because it is
illegal to do so in most states.
No-par capital stock is stock that does not carry a par value. When
a corporation issues no-par stock, some states require that the
corporation designate the entire proceeds received as legal capital.
Some states allow directors to establish a stated value per share of
no-par stock, when multiplied by the number of shares issued,
generally determines the amount of the corporation’s legal capital.
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Additional Paid-in Capital
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State law requires the corporation to record the par or stated
value.
Additional paid-in capital is the excess value received (the
difference between the exchange price and the par or stated
value) in each type of stock transaction.
While most companies use the term Additional Paid-in Capital,
you may also see the terms:
 Capital in Excess of Par (or Stated) Value
 Paid-in Capital in Excess of Par (or Stated) Value
 Additional Capital
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Issuance of Capital Stock
Learning Objective #3
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When a corporation issues only one class of capital stock, it is
referred to as common stock.
The corporate charter contains the authorization to issue
capital stock. This authorization is recorded in a memorandum
journal entry which identifies the number of authorized shares,
the par or stated value, and, in the case of preferred stock,
any preferred provisions.
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Accounting for the Issuance of Capital Stock
Example (Issuance for Cash) Powell Corporation issues 500
shares of its $5 par common stock for $16 per share. The
corporation’s journal entry for the issuance of stock is shown
below.
Cash ($16 × 500)
Common Stock, $5 par value ($5 × 500)
Additional Paid-in Capital on Common Stock
8,000
2,500
5,500
If the stock were no-par stock with a stated value of $5 per
share, the corporation would record the preceding transaction in
the same way and denote $5 stated value
For both situations, the number of shares issued can be determined as:
Number of Shares Issued =
Total Amount in the Common Stock Account
Par or Stated Value of the Shares
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Stock Issuance Costs
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A corporation may incur miscellaneous costs that arise from
issuing its capital stock.
 Legal fees
 Accounting fees
 Stock certificate fees
 Underwriter’s fees
 Promotional fees
 Postage
When these costs are incurred at the initial issuance of stock at
the time of incorporation, they are considered an organization
expense.
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Stock Subscriptions

Investors sometimes agree to purchase capital stock from a
corporation and pay at a later date.
 This creates a legally-binding subscription contract between
the corporation and the future shareholders.
 This contract requires the investor to buy a certain number
of shares at an agreed-upon price, with payment spread
over a specified time period.
 The contract often requires a down payment and may
require the investor to issue the company a promissory note.
 The contract will also set forth what will happen if the
investor is not able to pay and defaults.
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Combined Sales of Stock
(Slide 1 of 2)
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When a corporation issues different types of securities in a
combined sale, it allocates the proceeds between the securities
based on the relative fair value of each security.
If the fair value of only one of the securities are known, the fair
value amount is assigned to that security. The remaining
proceeds are assigned to the security with the unknown fair
value.
Example Brandt Corporation issues 100 “bundles” of securities
for $82.80 per bundle, or a total of $8,280.
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Each bundle includes two shares of $10 par common stock and one share
of $50 par preferred stock.
The separate fair values are $16 per share for the common stock and
$60 per share for the preferred stock.
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Combined Sales of Stock
(Slide 2 of 2)

Brant makes the following journal entry:
Cash
Common Stock, $10 par (200 shares)
Additional Paid-in Capital on Common Stock
Preferred Stock, $50 par (100 shares)
Additional Paid-in Capital on Preferred Stock
8,280
2,000
880
5,000
400
Supporting Computations:
Aggregate Fair Value
Common Stock: $16 × 2 shares × 100 packages = $3,200
Preferred Stock: $60 × 1 share × 100 packages =
6,000
$9,200
Allocation
$3,200
Common Stock:
× $8,280 = $2,880
$9,200
$6,000
Preferred Stock:
× $8,280 = 5,400
$9,200
$8,280
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Nonmonetary Issuance of Stock
(Slide 1 of 2)
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A nonmonetary exchange is any type of transaction in which a
corporation issues capital stock for assets other than cash, or for
services performed.
The general rule is to record the exchange at the fair value of the
stock issued or the asset received, whichever can be measured with
greater representational faithfulness.
Example (Fair Value of Stock Known) Capers Corporation issues
200 shares of $10 par common stock for a patent. The stock is
currently selling for $22 per share on the open market. Caper
records the following transaction:
Patent ($22 × 200)
Common Stock, $10 par
Additional Paid-in Capital on Common Stock
4,400
2,000
2,400
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Nonmonetary Issuance of Stock
(Slide 2 of 2)
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Stock may be closely held and not actively traded. The fair value
of the assets received may provide a more representationally
faithful value of the transaction.
Example (Fair Value of Asset Known) Eli Corporation issues 500
shares of $8 par common stock that is not widely traded for an
acre of land.
 An independent appraiser indicates the land is worth $20,000.
The transaction would be recorded as follows:
Land ($22 × 200)
Common Stock, $10 par
Additional Paid-in Capital on Common Stock
20,000
2,000
18,000
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Stock Splits
(Slide 1 of 2)
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To reduce the market price of a corporation’s stock so that it
falls within a desired “trading range” of most investors, a
corporation may authorize a stock split.
A stock split is proportionally decreases in market price and
par value per share of stock and increases the number of
shares issued.
A stock split also results in a proportional increase in the
number of shares authorized.
A reverse split increases the par value per share and
proportionally decreases the number of shares issued.
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Stock Splits
(Slide 2 of 2)
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Example Angie Corporation has 250,000 authorized shares
and has issued 60,000 shares of $10 par common stock.
 Angie declares a two-for-one stock split with a reduction to
a $5 par value.
 After the split, 500,000 shares are authorized, and a total
of 120,000 shares of $5 common stock are issued.
A corporation records a stock split by a memorandum entry
that indicates the new par value, the total number of shares
issued, and the impact on the number of authorized shares.
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Stock Warrants
(Slide 1 of 3)
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Stock warrants represent the right to purchase additional shares
of common stock at an established price, or exercise price.
Exercise price (or strike price) is the price at which the holder of
an option or warrant has the right to buy or sell the common stock.
Detachable warrants are warrants that can be separated from
the other security and traded independently.
Example Rehage Company issues 1,000 shares of $50 par
preferred stock with detachable warrants for $106,000 on
January 1, 2016.
 Each share of preferred stock is issued with 5 detachable
warrants. Each warrant entitles the holder to purchase one
share of common stock for $50. The warrants expire in 2 years.
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Stock Warrants
(Slide 2 of 3)
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The fair market value of the preferred stock is $72,000 on
January 1, 2016, and the warrants sell for $8 per warrant.
Rehage makes the following journal entry:
Cash
Preferred Stock
Additional Paid-in Capital on
Preferred Stock
Paid-in Capital—Common Stock
Warrants
106,000.00
50,000.00
18,142.86
37,857.14
Aggregate Fair Value
Preferred Stock
$ 72,000
Common Stock Warrants = 5,000 warrants × $8 =
40,000
$112,000
Allocation
Preferred Stock
($72,000/$112,000) × $106,000 = $68,142.86
Common Stock Warrants ($40,000/$112,000) × $106,000 = $37,857.14
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Stock Warrants
(Slide 3 of 3)

On July 1, 2016, the warrants are exercised to purchase common
stock (with a par value of $10 per share). The exercise price is $50
per share. Rehage should make the following entry:
Cash (5,000 warrants × $50)
Paid-in Capital—Common Stock Warrants
Common Stock (5,000 × $10 par value)
Additional Paid-in Capital on Common Stock

250,000.00
37,857.14
50,000.00
237,857.14
When the warrants are exercised, the Paid-in Capital—
Common Stock Warrants account is eliminated.
Consideration = Cash of $250,000 + Warrants valued at $37,857.14
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Noncompensatory Share Purchase Plans
Learning Objective #4
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A noncompensatory share purchase plan enables employees to buy
shares of stock, usually at a discount.
Three criteria must be met:
 All employees who meet specific employment qualifications may
participate in the plan on an equal basis.
 The discount from the market price does not exceed stock issuance
costs avoided by not issuing the stock to the public.
 The plan has no option features other than the following:
 Employees are allowed a short time to decide whether to enroll
 The purchase price is based solely on the market price of the
stock on the purchase date, and employees are permitted to
cancel their participation before the purchase date and obtain
a refund of any amounts previously paid.
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Share-Based Compensation Plans
Learning Objective #5
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A share-based compensation plan is a compensation
arrangement in which employees receive share options, shares
of stock, or cash payments based on the change in stock price
instead of cash bonus.
A compensatory share option plan is an arrangement
intended to provide additional compensation by rewarding
employees shares in the company or cash bonuses tied to
changes in the company’s stock price.
Restricted share awards and appreciation rights are
arrangements intended to provide additional compensation by
awarding employees shares in the company or cash bonuses
tied to changes in the company’s stock price.
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Overview of Compensatory
Share Option Plans
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In developing a compensatory share option plan, a company’s
objective is to better align the company’s goals with those of
management and its owners.
The grant date is the date on which the company provides the
share options to the employees.
The intrinsic value method is a method whereby a
corporation measures the total options-based compensation
cost for each employee as follows:
Total Options-Based
Compensation Cost
Number of
×
=
Share Options
Market Price of
Exercise Price of
the Stock on
‒ the Share Option
Date of Grant
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Accounting for Share-Based Compensation Plan

In response to the need for high-quality “transparent” financial
reporting, the FASB updated the accounting for share-based
compensation plan to require the use of the fair value method.
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
How Do We Account for Compensatory
Share Option Plans? (Slide 1 of 4)
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Option pricing models are used to estimate the fair value of
the option.
The option pricing model that a corporation uses must take into
account the following variables as of the grant date:
 Exercise price
 Expected life of the option
 Current market price of the underlying common stock
 Expected volatility of the stock price
 Expected dividends on the stock
 Risk-free interest rate for the expected term of the option
An option’s value is determined at the grant date as follows:
Option Value (Fair Value) = Current Stock Price ‒ Present Value of Exercise Price
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
How Do We Account for Compensatory
Share Option Plans? (Slide 2 of 4)
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The cost recognized by a company for its share-based
compensation plan is the total fair value of the share options
that actually become vested.
Vested occurs when an employee has fulfilled the service
requirement and has ownership of the share options.
If the corporation expects that a significant number of
employees will forfeit their options, then it records the
compensation expense each year based on an estimate of the
number of options expected to vest. The estimated total
compensation cost is determined at the grant date as follows:
Estimated Total
Compensation Cost
Fair Value
=
per Option
×
Estimate of the Number of Share
Options Expected to Vest
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How Do We Account for Compensatory
Share Option Plans? (Slide 3 of 4)
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A fixed share option plan is a plan in which all the terms (e.g.,
exercise price, number of shares) are set (“fixed”) on the grant
date.
Example On January 1, 2016, Fox Corporation adopts a
compensatory share option plan and grants 9,000 share
options (to acquire 9,000 shares of common stock) with a
maximum life of 10 years to 30 selected employees.
 The $50 exercise price is equal to the market price of the
stock on this grant date. All the options vest at the end of 3
years if the employee is still employed by the company.
 Fox expects 10% of the options to be forfeited.
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
How Do We Account for Compensatory
Share Option Plans? (Slide 4 of 4)
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At the end of 2015, a total of 7,500 share options for 25
employees actually vest, and the other 1,500 are forfeited. Fox
determines that the fair value of each option is $18 on the grant
date.
The total options-based estimated compensation cost on the grant
date for this fixed share option plan is determined as follows:
Total Options-Based Estimated
Compensation Cost
= Fair Value × Number of Options
per Option
Expected to Vest
= $18
× (9,000 × .09)
= $145,800

On January 1, 2016 (the grant date), Fox makes a memorandum
entry to summarize the terms of the compensatory share option
plan.
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Fixed Compensatory Share Option Plan
Fox Corporation
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Performance-Based Option Plans
(Slide 1 of 2)
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Performance-based share option plans (or variable-term share
option plans) are plans in which one or more terms are not fixed
at the grant date. These plans are set up so that the terms will
vary depending on how well the selected employees perform
during the service period.
Example The terms of Fox Corporation’s performance-based plan
adopted on January 1, 2016, are the same as in the previous
example (3-year vesting and service period, $50 exercise price,
and $18 fair value per option) except, Fox grants each of the 30
selected employees a minimum of 300 share options.
 The options vest in differing numbers depending on the market
share of Fox’s products over the 3-year period.
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Performance-Based Option Plans
(Slide 2 of 2)
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Terms of the plan are that by December 31, 2015:
 If the market share has increased by at 5%, at least 100 share
options will vest for each employee on that date.
 If the market share has increased by at least 10%, another 100
share options will vest for each employee, for a total of 200.
 If the market share has increased by more than 20%, all 300
share options will vest for each employee.
At the end of 2015, Fox determines that its market share has
increased over the 3-year period by more than 20%. In
addition, at the end of 2015, 25 employees vest in 7,500 share
options.
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Performance-Based Compensatory
Share Option Plan
Fox
Corporation
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Restricted Share Plan
(Slide 1 of 4)

Because some employees who qualify to buy shares of stock in
a compensatory plan have a cash-flow problem, corporations
have developed share-based plans involving restricted shares.
 A restricted share plan is a plan in which employees are
granted actual shares of stockn.
 While the employee becomes an actual shareholder on the
date of the grant, the company maintains physical
possession of the shares, restricting the employee’s ability
to sell the shares until the employee reaches certain goals.
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Restricted Share Plan
(Slide 2 of 4)

Compensation cost for restricted share plans is determined
using the fair value method and is calculated as follows:
Total Compensation
Market Price of the Share on
Number of Restricted
×
=
Cost
Date of Grant
Shares Awarded

Example On January 3, 2016, Taos Corporation hires a new
Director of Accounting.
 In addition to salary and other benefits, the employment
package grants 10,000 restricted shares of Taos common
stock that vest in 3 years if the director is still an employee.
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Restricted Share Plan
(Slide 3 of 4)

On January 3, 2016, the $5 par value common stock is trading
at $63 per share. The restricted share award is calculated as:
Total Compensation
Market Price of the Share on
Number of Restricted
×
=
Cost
Date of Grant
Shares Awarded
$630,000
=
$63
× 10,000 share units

Taos would recognize $210,000 ($630,000 ÷ 3 years) of
compensation expense for each of the three required years :
December 31, 2016
Compensation Expense
Paid-in Capital from Restricted Shares

210,000
210,000
If the Director of Accounting is still an employee at the end of 3
years, the shares would vest and no longer be restricted.
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Restricted Share Plan
(Slide 4 of 4)

Taos would issue 10,000 common shares to the employee :
December 31, 2015
Paid-in Capital from Restricted Shares
630,000
Common Stock (10,000 × $5 Par Value)
50,000
Additional Paid-in Capital from Common Stock
580,000

If the Director of Accounting left Taos on March 1, 2015, Taos
would make the following journal entry to reverse the 2 years
of compensation expense previously recorded.
March 1, 2015
Paid-in Capital from Restricted Shares
Compensation Expense
420,000
420,000
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Share Appreciation Rights



Share appreciation rights (SARs) are rights granted to selected
employees that enable them to receive cash, shares, or a
combination of both equal to the excess of the market value over
a stated price of the corporation’s stock on the date of exercise.
A company accounts for a SARs plan using the fair value method.
 For SARs the fair value can only be determined on the date
the rights are exercised.
To record the compensation expense for the SARs plan, an
estimate of the total compensation cost is made at the end of
each year based on the fair value of the SARs at that time.
Adjustments are made after each service period has expired.
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Recognition of Compensation Cost Under SAR
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Share Appreciation Rights
(Slide 2 of 3)


Example On January 1, 2016, when the market price is $60 per
share, Wolf Corporation grants share appreciation rights to a
selected employee, Tom Essman.
 Under the SAR plan, Tom will receive cash for the difference
between the quoted market price and $60 for 1,000 shares
of Wolf’s common stock on the date of exercise.
 The service period is 4 years and the rights must be exercised
within 10 years of the grant date.
On the grant date, Wolf estimates that the fair value of each
SAR is $17. Wolf makes a memorandum entry on January 1,
2016, indicating that the estimated fair value of this SAR award
is $17,000.
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Share Appreciation Rights
(Slide 3 of 3)

On December 31, 2016, the fair value per SAR is $20.
 On that date, Tom exercises the rights when the quoted
market price of Wolf’s stock is $94 per share.
 Tom’s compensation is calculated:
$20 x 1,000 shares = $20,000

The journal entry to record the compensation earned in the
first year of the four-year period, is:
Compensation Expense
SAR Compensation Payable
5,000
5,000
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SAR Annual Compensation Expense
The journal entry to record the compensation earned in the second
year:
Compensation Expense
SAR Compensation Payable
10,000
10,000
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Characteristics of Preferred Stock
Learning Objective #6

Various preferred stock characteristics may be specified in
preferred stock contract:
 Preference as to dividends
 Accumulation of dividends
 Participation in excess dividends
 Convertibility to common stock
 Attachment of stock warrants
 Callability by the corporation
 Mandatory redemption at a future maturity date
 Preference to assets upon liquidation of the corporation
 Lack of voting rights
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Preference as to Dividends


A corporation must pay any applicable dividends to preferred
shareholders before a dividend may be paid to common
shareholders.
Example Tusker Corporation has outstanding 5,000 shares of
6%, $100 par preferred stock.



Each preferred shareholder is entitled to an $6 (6% × $100) annual
dividend per share.
The corporation must pay $30,000 of dividends (6% × $100 ×
5,000) to preferred stockholders before it may pay any dividends
to common shareholders.
A preference as to dividends does not guarantee that a
corporation will pay a preferred dividend in any given year.
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Cumulative Preferred Stock
(Slide 1 of 2)


Noncumulative preferred stock is stock carrying the provision
that the holder will never be paid a dividend in a particular
year if dividends are not declared in that year.
Cumulative preferred stock is stock carrying the provision
that, if a corporation fails to declare a dividend on cumulative
preferred stock at the stated rate on the usual dividend date,
the amount become dividends in arrears.
 Dividends in arrears accumulate from period to period.
 Dividends in arrears are not liabilities.
 A corporation cannot pay common shareholders any
dividends until it has paid the preferred dividends in
arrears.
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Cumulative Preferred Stock
(Slide 2 of 2)

Example Kali Corporation has outstanding 1,000 shares of 10%,
$100 par cumulative preferred stock. Each share of stock is
entitled to a $10 annual dividend (10% × $100 par value).
 If Kali does not pay dividends in 2016 and 2017, preferred
shareholders would be entitled to dividends in arrears of:
$10,000 at the end of 2016 (1,000 shares × $10 per share)
$20,000 at the end of 2017 (1,000 shares × $10 per share × 2 years)

At the end of 2018, Kali would have to pay $30,000 (1,000
shares × $10 per share × 3 years) to preferred stockholders
before it could pay any dividends to common stockholders.
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Participating Preferred Stock


Participating preferred stock is stock carrying the provision
that preferred shareholders share with the common
shareholders in any additional dividends.
Participating preferred stock may be either fully or partially
participating.
 Fully participating preferred shareholders are
shareholders who share equally with the common
shareholders in any extra dividends.
 Partially participating preferred shareholders are
shareholders who share in extra dividends, but the
participation is limited to a fixed rate or amount per share.
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Convertible Preferred Stock
(Slide 1 of 2)



Convertible preferred stock is stock with a provision that
allows shareholders, at their option and under specified
conditions, to convert the shares of preferred stock into another
security of the corporation.
Accounting for the conversion of preferred to common stock is
very straightforward because the book value method is used.
Example Pender Corporation originally issued 500 shares of
$100 par convertible preferred stock at $120 per share.
 Each preferred share may be converted into four shares of
$20 par common stock and all shares are converted.
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Convertible Preferred Stock
(Slide 2 of 2)

Pender makes the following journal entry at conversion:
Preferred Stock, $100 par
50,000
Additional Paid-in Capital on Preferred Stock 10,000
Common Stock, $20 par (4 × 500 × $20)
40,000
Additional Paid-in Capital from Preferred
Stock Conversion ($60,000 ‒ $40,000)
20,000

If the total contributed capital eliminated for the
preferred stock is more than the common stock par value,
the corporation records the excess as an increase in
additional paid-in capital related to the conversion.
The conversion of preferred to common stock changes the
components of shareholders’ equity, but does not affect the
corporation’s total shareholders’ equity.
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Preferred Stock with Stock Warrants
(Slide 1 of 3)




A corporation may also attach warrants to preferred stock to
enhance their attractiveness.
These warrants represent rights that allow the holder to
purchase additional shares of common stock at a specified
price over some future period.
Because these warrants are detachable from the preferred
stock, they usually begin trading on the stock market at some
market price.
The investor in detachable preferred stock has dual rights:
 Right to dividends that will be paid on the preferred stock
 Right to the market value appreciation of the common stock
that may be purchased as a result of the warrants
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Preferred Stock with Stock Warrants
(Slide 2 of 3)

Example Belmont Corporation issues 1,000 shares of $100
par value preferred stock at a price of $120 per share.


It attaches a warrant to each share of stock that allows the holder
to purchase one share of $10 par common stock at $40 per share.
Immediately after the issuance, the preferred stock begins selling
ex rights (without the rights attached) on the market for $119 per
share and the warrants begin selling for $6 each.
Preferred Stock:
$119,000
$119,000 + $6,000
× $120,000 = $114,240
Common Stock Warrants:
$6,000
$119,000 + $6,000
× $120,000 =
5, 760
$120,000
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Preferred Stock with Stock Warrants
(Slide 3 of 3)

Belmont makes the following journal entry:
Cash ($121 × 1,000 shares)
Preferred Stock, $100 par
Additional Paid-in Capital on Preferred
Stock
Common Stock Warrants

120,000
100,000
14,240
5,760
Assuming all warrants are exercised. Belmont makes the
following journal entry to record the issuance of the 1,000
shares of common stock in exchange for the warrants and $40
per share:
Cash ($40 × 1000 shares)
Common Stock Warrants
Common Stock, $10 par
Additional Paid-in Capital on Common Stock
40,000
5,760
10,000
35,760
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Callable Preferred Stock


Callable preferred stock is stock that may be retired (recalled)
under specified conditions by a corporation at its discretion.
Example Li Corporation has outstanding 1,000 shares of $100
par callable preferred stock that were issued at $110 per
share and that have no dividends in arrears.
 If the call price is $112 per share, Li makes the following
journal entry to record the call of these shares:
Preferred Stock, $100 par
Additional Paid-in Capital on Preferred Stock
Retained Earnings ($112,000 ‒ $110,000)
Cash ($112 × 1,000 shares)
100,000
10,000
2,000
112,000
The debit to Preferred Stock is a permanent
reduction to Stockholders’ Equity.
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Redeemable Preferred Stock




In contrast to convertible preferred stock and callable
preferred stock, some preferred stock is redeemable.
Redeemable preferred stock is stock that may either be
subject to mandatory redemption at a specified future
maturity date for a specified price or redeemable at the
option of the holder.
Mandatory redeemable preferred stock is reported as a
liability, not equity, because of the obligation of a cash outflow
in the future that the company has no ability to prevent.
Preferred stock that is redeemable at the option of the holder
is not reported as a liability. It is reported in shareholders’
equity.
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Preference in Liquidation




If a corporation is liquidated, the preferred stock contract
usually allows the preferred shareholders liquidation
preference over the common shareholders (but secondary to
creditors).
The preference is typically expressed as a percentage of (or
equal to) the par value.
It also frequently requires the payment of dividends in arrears.
A corporation discloses this information either parenthetically in
its shareholders’ equity section or in the notes accompanying its
financial statements.
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Treasury Stock
Learning Objective #7


Treasury stock is a corporation’s own capital stock that (1) has
been fully paid for by the shareholders, (2) has been legally
issued, (3) reacquired by the corporation, and (4) is being held
by the corporation for future issuance.
A corporation may acquire treasury stock to:
 Use for share option, bonus, and employee purchase plans
 Use in the conversion of convertible preferred stock or bonds
 Use excess cash
 Use in acquiring other companies
 Signal to the capital market that the company managers
believe the shares are underpriced
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What is Treasury Stock and
How is it Accounted For? (Slide 2 of 3)




Reduce the number of shares held by hostile shareholders and
thereby reduce the likelihood of being acquired by another
company
Use for the issuance of a stock dividend
Treasury stock is not an asset.
To ensure that treasury stock is handled in the best interest of
the shareholders, states have passed laws regulating
corporate activities as follows:



A corporation must acquire treasury stock for some legitimate
corporate purpose.
Treasury stock does not vote, has no preemptive rights, ordinarily
cannot participate in dividends or liquidation.
Treasury stock does not participate in stock splits.
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What is Treasury Stock and
How is it Accounted For? (Slide 2 of 3)




The acquisition of treasury stock does not formally reduce a
corporation’s legal capital.
Treasury stock transactions may reduce retained earnings but
may never increase retained earnings.
If the treasury shares are not retired, the corporation may
reissue the treasury stock at a price above or below the
acquisition price or the par value.
A corporation may account for treasury stock transactions by
either the cost method or the par (stated) value method. The cost
method is used by the vast majority of companies that hold
treasury stock.
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Cost Method
(Slide 1 of 2)


Under the cost method, when the corporation reacquires its
capital stock, it assumes it will reissue rather than retire the
stock.
Example Ball Corporation is authorized to issue 20,000 shares
of $10 par common stock and enters into several treasury
stock transactions as follows:
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Cost Method
(Slide 2 of 2)
Note that treasury stock was
reissued at less than par.
Note that the retained
earnings account is
debited for $100.
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Balance Sheet Presentation
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Contributed Capital Section Structure
Learning Objective #8
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Real Report: Contributed Capital
(Slide 1 of 3)
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Real Report: Contributed Capital
(Slide 2 of 3)
1. What is the par value of Starbucks’s common stock? How many more shares can
Starbucks issue as of September 29, 2013? The par value of Starbucks’s common
stock is $0.001 per share. Starbucks has authorized 1,200 million shares of common
stock and has issued and outstanding shares at September 29, 2013 of 753.2
million, so the company may issue 446.8 million additional shares.
2. How many shares of common stock did Starbucks repurchase and retire during the
fiscal year ended September 29, 2013? What was the effect of these transactions
on shareholders’ equity? What was the average price paid per share acquired
during 2010? Starbucks repurchased and retired 10,800,000 shares of common stock
during 2013. This reduced Additional Paid-in Capital by $288,500,000. The average
price for a share of common stock was $50.52
3. How many classes of capital stock have been authorized by Starbucks?
Starbucks has authorized both preferred and common; however, the company has not
issued any preferred shares.
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