Post on 27-Oct-2014
Lecture
Equity Part 1
Dr Winston Kwok
Lecture Learning Objectives
1. Explain the characteristics of a corporation
2. Measure the effect of issuing stock on acorporation’s financial position
3. Contrast dividends for common stock withdividends for preferred stock
4. Account for treasury stock and other items inequity
Learning Objective 1
Explain the characteristics
of a corporation
What is the Best Way toOrganize a Business?
Proprietorship
Partnership
Corporation orCompany
Corporations: An Overview
May be fewer in number than soleproprietorships and partnerships, yet ...
Generate greatest dollar volume of salesrevenues
Largest in terms of total assets andowners’ equity
Privately HeldPrivately Held
Publicly HeldPublicly Held
Ownershipcan be
Corporate Form of Organization
Existence isseparate from
owners
An entitycreated by law
Has rights andprivileges
Company accounting
Going public means selling shares togeneral public.
Initial public offering or IPO is first offerof shares.
Going public allowed a company to raiselarge amounts of capital for current andfuture expansion
Less risky (and less costly) to obtainmoney from investors than borrowing itfrom one or more lenders
Company going public typically enlistsservices of financial professionals suchas underwriters
Advantages
Separate legal entity
Limited liability of stockholders
Transferable ownership rights
Continuous life
Lack of mutual agency for stockholders
Ease of capital accumulation
Disadvantages
Governmental regulation
Corporate taxation
Characteristics of Corporations
Organizing a Corporation
CharterIncorporators
Set bylaws
Authority Structureof a Corporation
Stockholders
Board of Directors
Chairperson of the Board (CEO)
President (Chief Operating Officer)
Authority Structureof a Corporation
President (Chief Operating Officer)
VPSales
VPManufacturing CFO
VPPersonnel Secretary
Controller(Accounting Officer)
Treasurer(Finance Officer)
Vote at stockholders’ meetings
Sell stock
Purchase additional shares ofstock (preemptive right)
Receive dividends, if any
Share equally in any assetsremaining after creditors are paidin a liquidation
Rights of Stockholders
Stockholders’ Equity
Capital stock
Retained earnings
Owners’ equity in a corporationhas two main components:
Capital Stock
Common Stock
The most basic formof capital stockissued by every
corporation.
Preferred Stock
A class of stockthat has severalpreferences overcommon stock.
Capital Stock
Par Value Stock
It is an arbitraryamount assigned
by a company to ashare of its stock.
No-par Stock
Does not have a parvalue, but may have
a stated value (anarbitrary amount).
Learning Objective 2
Measure the effect of issuingstock on a corporation’s
financial position
The maximumnumber of
shares of capitalstock that can be
sold to thepublic.
AuthorizedAuthorizedShares
Authorization and Issuanceof Capital Stock
Issuedshares areauthorizedshares ofstock thathave been
sold.
Unissuedshares areauthorizedshares ofstock thatnever havebeen sold.
Usuallyshares are
soldthrough anunderwriter.
AuthorizedAuthorizedShares
Authorization and Issuanceof Capital Stock
Issuing Stock
Corporations need money to operatefrom sources other than borrowing.
Par Value
No-Par Value
Stated Value
Common Stock at Par
Suppose IHOP’s common stockcarries a par value of $10 per share.
The company issues 6,200,000shares of common stock at par.
What is the entry?
Common Stock at Par
Cash (6,200,000 × $10) 62,000,000Common Stock 62,000,000
Issued common stock at par
Common Stock at Par
IHOP can also give shares of itscommon stock to underwriters or
promoters for their services.
The company gave promoters1,000,000 shares ofcommon stock at par.
What is the entry?
Common Stock at Par
Organization Expenses (1m × $10) 10,000,000Common Stock 10,000,000
Gave promoters 1 million shares of $10 par valuein exchange for their services
Common Stock Above Par
IHOP’s common stock has apar value of $0.01 per share.
The company issues 6,200,000 sharesof common stock at $10 per share.
What is the entry?
Common Stock Above Par
Cash (6,200,000 × $10) 62,000,000Common Stock
(6,200,000 × $0.01) 62,000Paid-in Capital in Excess of Par Value,
Common Stock (6,200,000 × $9.99) 61,938,000Issued common stock above par
Paid-in Capital in Excess of Par Valuealso known as Contributed Capital in Excess of Par Value or
Additional Paid-in Capital
Common Stock Above Par
Common Stock, $.01 par;40 million shares authorized,6.2 million shares issued $ 62,000
Paid-in Capital in Excess of Par Value,Common Stock 61,938,000Total Paid-in Capital $ 62,000,000Retained Earnings 194,000,000Total Stockholders’ Equity $256,000,000
Stockholders’ Equity
No-Par Common Stock
When a company issues no-par stock with astated value of $20 per share, it debits
the asset received and credits the stock account.
Cash (3,000 × $20) 60,000Common Stock 60,000
Issue 3,000 no-par common stock at $20 per share
A separate class of stock, typically havingpriority over common stock in . . .
Dividend distributions (rate is usuallystated).
Distribution of assets in case of liquidation.
Cumulativedividendrights.
Normally hasno voting
rights.
Usually callableor redeemable
by the company.
Other Features Include:
Preferred Stock
Preferred Stock
Reasons for issuing:
To raise capital without sacrificing control
To boost the return earned by commonstockholders through financial leverage
To appeal to investors who may believe thecommon stock is too risky or that theexpected return on common stock is toolow
Accounting for preferred stock follows thepattern illustrated for common stock
Issuing Stock for Assets Otherthan Cash
Investors sometimes contribute long-termassets to company instead of cash
Determine, through independentappraisal, asset’s fair value (market value)
or, the shares’ fair value (market value)
whichever is more readily determinable
An investor contributes land and abuilding in exchange for 5,000 shares ofAsian Art, Inc., common stock, with a parvalue of $2 per share
Real estate appraisals
Land = $25,000
Building = $150,000
What’s the journal entry to recognize thistransaction?
Issuing Common Stock forAssets Other than Cash
Land 25,000
Building 150,000
Common Stock (a) 10,000
Paid-in Capital in Excess of Par Value,Common Stock (b) 165,000
(a) Common Stock = 5,000 shares @ $2.00 par
(b) Paid-in Capital in Excess of Par Value, Common Stock =$175,000 fair value of PP&E less $10,000 par value of shares
Issuing Common Stock forAssets Other than Cash
Issuing Preferred Stock
Asian Art Inc. would follow same systemof recording share transactions whenissuing preferred stock
Debit = Cash or assets
Credit = Preferred Stock and Paid-inCapital in Excess of Par Value, PreferredStock (if necessary)
Ethical Considerations
Issuing stock for assets other than cashcan pose an ethical challenge.
The company issuing the stock often wishesto record a large amount for the noncash asset
received and for the stock that it is issuing.
Learning Objective 3
Contrast dividends for common stockwith dividends for preferred stock
Three important datesThree important dates
Date of Declaration
Record liabilityfor dividend.
Date of Record
No entryrequired.
Date of Payment
Record payment ofcash to stockholders.
Entries for Cash Dividends
Date of DeclarationRecord liability
for dividend.
On January 19, a $1 per share cash dividend isOn January 19, a $1 per share cash dividend isdeclared on Dana, Inc.’s 10,000 common sharesdeclared on Dana, Inc.’s 10,000 common sharesoutstanding. The dividend will be paid on March 19 tooutstanding. The dividend will be paid on March 19 tostockholders of record on February 19.stockholders of record on February 19.
Entries for Cash Dividends
Dr Cr
Jan. 19 Retained earnings 10,000
Common dividend payable 10,000
Declared $1 per share cash dividend
Instead of debiting RE, can debit a temporary accountDividends which will be closed at end of period
Date of RecordNo entryrequired.
Entries for Cash Dividends
On January 19, a $1 per share cashOn January 19, a $1 per share cashdividend is declared on Dana, Inc.’sdividend is declared on Dana, Inc.’s10,000 common shares outstanding.10,000 common shares outstanding.The dividend will be paid on MarchThe dividend will be paid on March19 to stockholders of record on19 to stockholders of record onFebruary 19.February 19.
No entry required onFebruary 19.
Date of PaymentRecord payment of
cash to stockholders.
Entries for Cash Dividends
On January 19, a $1 per share cashOn January 19, a $1 per share cashdividend is declared on Dana, Inc.’s 10,000dividend is declared on Dana, Inc.’s 10,000common shares outstanding. The dividendcommon shares outstanding. The dividendwill be paid on March 19 to stockholders ofwill be paid on March 19 to stockholders ofrecord on February 19.record on February 19.
Dr Cr
Mar. 19 Common dividend payable 10,000
Cash 10,000
Paid $1 per share cash dividend
Created when a company incurs cumulativelosses or pays dividends greater than total
profits earned in other years.
Stockholders' Equity
10,000 shares authorized and outstanding 100,000$
(8,500)
91,500$
Retained earnings deficit
Total stockholders' equity
Dana, Inc.
Balance Sheet (Stockholders' Equity Section)
December 31, 2008
Common stock $10 par value,
Deficits and Cash Dividends
Cash Dividends
When a company has issued bothpreferred and common stock,
the preferred stockholdersreceive their dividends first.
Pinecraft Industries, Inc., has bothcommon stock and 90,000 shares
of preferred stock outstanding.
Expressing the Dividend Rateon Preferred Stock
Percentage rate
Dollar amount
Cash Dividends
Preferred dividend (90,000 × $1.75 per share) $157,500Common dividend
(remainder: $1,500,000 – $157,500) 1,342,500Total dividend $1,500,000
Preferred dividends are paid at the annualrate of $1.75 per share.
Assume that in 2004, the company declaresan annual dividend of $1,500,000.
Vs. NoncumulativeCumulative
Dividends inarrears must be
paid beforedividends may bepaid on common
stock.
Undeclareddividends from
current and prioryears do not haveto be paid in future
years.
Cumulative Preferred Stock
Cash Dividends
The preferred stock of Pinecraft is cumulative.
Retained Earnings 500,000Preferred Dividend Payable 315,000*Common Dividend Payable($500,000 – $315,000) 185,000
Declare a cash dividend*($157,500 × 2 years)
Suppose the company did not pay the 2004preferred dividend of $157,500.
In 2005, the company declares a $500,000 dividend.
Preferred stock, 9%, $100 par value; 1,000
shares authorized and issued 100,000
Common stock, $50 par value; 4,000 shares
authorized and issued 200,000$
Total contributed capital 300,000$
Example: Consider the following partial Statement ofStockholders’ Equity.
During 2007, the directors declare cash dividendsof $5,000. In 2008, the directors declare cash
dividends of $42,000.
Stock Preferred as to Dividends
Stock Preferred as toDividends
Preferred Common
If Preferred Stock is Noncumulative:
Year 2007 $5,000 dividends declared 5,000$ -$
Year 2008
Step 1: Current preferred dividend 9,000$
Step 2: Remainder to common shareholders 33,000$
If Preferred Stock is Cumulative:
Year 2007 $5,000 dividends declared 5,000$ -$
Year 2008
Step 1: Dividends in arrears 4,000$
Step 2: Current preferred dividend 9,000
Step 3: Remainder to common shareholders 29,000$
Totals 13,000$ 29,000$
Stock Preferred as to Dividends
I just converted 100 sharesof preferred stock into
1,000 shares of commonstock
Gee, I can’tdo that with
MYMY preferredstock!
Some preferredstock is convertible
into shares ofcommon stock.
Other Features of PreferredStock
Book Value per Shareof Common Stock
Total Stockholders’ EquityNumber of Common Shares Outstanding
Preferred stock and preferreddividends in arrears are deductedfrom total stockholders’ equity.
Book Value Market Value=
Learning Objective 4
Account for treasury stock and otheritems in equity
UnissuedUnissuedSharesShares
TreasuryStock
OutstandingShares
Treasury stock areissued shares that
have been reacquiredby the corporation.
IssuedShares
Outstanding shares areissued shares that are
owned bystockholders.
AuthorizedAuthorizedShares
Authorization and Issuanceof Capital Stock
Treasury Stock Transactions
Treasury stock are shares that a companyhas issued and later reacquired.
Stock option distribution(assuming at maximum authorized stock)
Increase share price
Avoidance of a takeover
Some reasons for purchasing own stock:
No votingNo votingoror
dividenddividendrightsrights
Contraequity
account
When stock is reacquired, the corporationrecords the treasury stock at cost.
Treasuryshares are
issuedshares thathave beenreacquired
by thecorporation.
Treasury Stock
Date Description Debit CreditDate Description Debit Credit
May1 TreasuryStock 165,000
Cash 165,000
3,000 shares × $55 = $165,000
On May 1, 2007, East, Inc. reacquires 3,000 sharesof its common stock at $55 per share.
Prepare the journal entry for May 1.
Treasury Stock - Example
Date Description Debit Credit
Dec. 3 Cash 75,000
TreasuryStock 55,000
Additional Paid-in Capital:
Treasurystock transactions 20,000
On December 3, 2007, East Corp. reissued 1,000shares of the stock at $75 per share.
Prepare the journal entry for December 3.
Treasury Stock - Example
Date Description Debit Credit
Dec. 3 Cash 75,000
Treasury Stock 55,000
Paid-in Capital,
Treasury Stock 20,000
1,000 shares × $55 cost = $55,000
1,000 shares × $75 = $75,000
Debit the excess of cost over sellingprice to Paid-in capital, treasury stock.
If not sufficient, then debit to RE
Selling Treasury StockBelow Cost
Retirement of Stock
It decreases the outstanding stockof the corporation.
Retired shares cannot be reissued.
There is no gain or loss on retirement.
Stockholders' Equity
Contributed capital:
Preferred Stock - $100 par value; 1,000 shares
authorized; 50 shares issued 5,000$
Common Stock - $10 par value; 50,000 shares
authorized; 30,000 shares issued 300,000
Additional Paid-in Capital: Common 21,000
Retained earnings 65,000
Subtotal 391,000$
Less: Treasury stock 110,000
Total Stockholders' equity 281,000$
Stockholders’ Equity -Presentation
Contra-equity
Legal Contractual
Most states restrictthe amount oftreasury stock
purchases to theamount of retained
earnings.
Loan agreements
retained earnings.
Loan agreementscan include
restrictions onpaying
dividends below acertain amount ofretained earnings.
Restricted Retained Earnings
A corporation’s directors can voluntarily limitdividends because of a special need for cash
such as the purchase of new facilities.
Retained earnings, 1/1/08 875,000$
Plus: net income 155,600
Less: dividends declared (80,000)
Retained earnings, 12/31/08 950,600$
Appropriated retained earnings (450,000)
Unappropriated retained earnings 500,600$
Reed, Inc.
Statement of Retained Earnings
For Year Ended December 31, 2008
Appropriated RetainedEarnings
Correction of material errors in past years’ financialstatements. If an amount is incorrectly expensed,
add amount to Retained Earnings.
Retained earnings, 12/31/07, as previously reported 875,000$
Prior period adjustment: Cost of land incorrectly
expensed 72,000
Retained earnings, 12/31/07, as adjusted 947,000
Plus: net income 155,600
Less: dividends declared (80,000)
Retained earnings, 12/31/08 1,022,600$
Reed, Inc.
Statement of Retained Earnings
For Year Ended December 31, 2008
Prior Period Adjustments
(In millions) Retained
Shares Amount Earnings Total
Balance at January 1, 2008 821 2,500$ 9,500$ 12,000$
Stock issuances 17 500 500
Stock repurchases and retirement (17) (260) (925) (1,185)
Cash dividends declared (150) (150)
Other, net 70 70
Net income 5,100 5,100
Balance at December 31, 2008 821 2,740$ 13,595$ 16,335$
Common stock and
capital in excess of par
Matrix, Inc.
Statement of Stockholders' Equity
For the Year Ended December 31, 2008
Statement of Stockholders’Equity
This is a more inclusive statement than the statement ofretained earnings.