11

7/e

PowerPoint Author: Catherine Lumbattis

COPYRIGHT © 2011 South-Western/Cengage Learning

Stockholders’Equity

Statements and

the Annual Report

Disadvantages

Advantages

Advantages of Stock vs. Debt Financing Flexibility Exchanges

facilitates trading Return on

investment

LO1

Disadvantages of Stock vs. Debt Financing

Control Tax consequences Impact on ratios

Disadvantages

Advantages

Expanded Accounting Equation

Assets = Liabilities + Owners’ Equity

Assets = Liabilities + Stockholders’ Equity

Contributed Capital

RetainedEarnings

Retained Earnings Connects the Income Statement and Balance Sheet

Statement of Retained Earnings Retained Earnings, Beginning Balance $ xxxAdd: Net Income incDeduct: Dividends xxxRetained Earnings, Ending Balance $ end

Balance Sheet Total Assets $ xxxTotal Liabilities $ xxx

Stockholders’ Equity xxxRetained Earnings end

Total Liabilities and Stockholders' Equity $ xxx

Income Statement Revenues $ xxxLess: Expenses xxxNet Income $ Net Inc

Stockholders’ Equity Components

Common Stock

Preferred Stock

AdditionalPaid-inCapital

RetainedEarnings

TreasuryStock

Contributed CapitalCommon Stock

• Basic stock of corporation• Normally carries voting rights

Preferred Stock• Optional• Tailored to meet specific needs

Outstanding: notrepurchased or retired

Issued: sold or distributed

Number of Shares of Stock

Authorized MaximumAllowable

Par Value“Legal capital”Arbitrary amount stated on stock

certificateAlso called “stated value”

Additional Paid-in CapitalAmount received in excess of par

when stock was originally issued

Retained EarningsNet income retained in the business (not

paid out as dividends) since its inceptionReinvested in a variety of assets (not

necessarily liquid or cash)

IFRS and Stockholders’ Equity International standards differ from U.S. standards for those

items that have attributes of both debt and equityConvertible stock must be separated into a part that is

presented in the Liability section and another part that is presented as Stockholders’ Equity section of the Balance Sheet

Preferred StockCan tailor to specific needs of firmStated dividend rate

• Percentage of the stock’s par value• Per-share amount

Often carries dividend preference over common stock

LO2

Preferred Stock Features

Callable

Convertible

Cumulative

Participating

Stock Issued for Cash

Cash 15,000 Common Stock 10,000 Additional Paid-In Capital—Common 5,000 To record the issuance of 1,000 shares of $10 common stock at $15 per share.

LO3

1,000 shares of $10 par value

stock sold for $15 per

share

Common Stock $ 10,000( $10 par value × 1,000 shares)

Additional Paid-In Capital $5,000 ([$15 – $10] × 1,000 shares)

Example:

Stock Issued for Noncash Consideration

Record at fair market value of consideration given or received, whichever is more readily determinable

BuildingCommon or

PreferredStock

Treasury Stock Company buys back its own stock Contra-equity account (debit balance) Not outstanding (no voting rights)

LO4

Reasons for Repurchasing Stock

Provide for employee bonuses or benefit plansMaintain a favorable market price Improve financial ratiosMaintain control of ownershipPrevent unwanted takeover or buyout attempts

Presentation of Treasury StockCommon stock, $10 par value, 1,000

shares issued, 900 outstanding $10,000Additional paid-in capital—Common 12,000Retained earnings 15,000Total contributed capital and retained earnings 37,000Less: Treasury stock, 100 shares at cost ($25 per share) 2,500

Total stockholders’ equity $34,500

Retirement of StockRepurchase of stock and is not intended to be resoldA proportional amount of the related Stock and

Paid-In Capital accounts must be eliminated

Cash Dividends

Paidto

Stockholderson date of record

Date of declaration

Paymentdateon

LO 5

Dividend RequirementsSufficient cashPositive retained earnings

Dividend Payout Ratio

Annual Dividend AmountAnnual Net Income

The % of earnings paid as dividends

Dividends Journal entry required to record: (1) dividends declared (2) dividends paid

Reduce retained earnings

12/31/10 1/15/11

Pay dividends

Recording Cash DividendsRetained Earnings XXX

Cash Dividend Payable XXX

To record the declaration of a cash dividend.

Cash Dividend Payable XXXCash XXX

To record the payment of a cash dividend.

Allocation of Common and Preferred Cash Dividends

1. Distribute dividends in arrears, if any, to preferred

2. Distribute current year’s dividends to preferred

3. Distribute remainder to common (or to both if preferred is participating)

Cash Dividends ExampleStricker Company declares a $70,000 dividend in 2010 (no dividends were paid in 2008 or 2009). There are 10,000 shares of $10 par, 8% preferred stock and 40,000 shares of $5 par common stock outstanding.

Cash Dividends Example

To Preferred To CommonStep 1: Distribute current-year dividend to preferred (10,000 shares × $10 par × 8% × 1 year) $8,000Step 2: Distribute remaining dividend to common ($70,000 – $8,000) $62,000Total allocated $8,000 $62,000

Noncumulative Preferred Stock

$0.80per

share

$1.55per

share

Cash Dividends Example To Preferred To

CommonStep 1: Distribute dividends in arrears to preferred (10,000 shares × $10 par × 8% × 2 years) $16,000Step 2: Distribute current-year dividendto preferred (10,000 shares × $10 par ×8% × 1 year) 8,000Step 3: Distribute remainder to common($70,000 – $24,000) $46,000Total allocated $24,000 $46,000

Cumulative Preferred Stock

$2.40per

share

$1.15per

share

Stock Dividends

Reasons:• Insufficient cash• Market price reduction• Nontaxable to recipients

Issue of additional shares proportionately to existing stockholders

LO6

Stockholders’ Equity:Common stock, $10 par, 5,000 shares

issued and outstanding $ 50,000Additional paid-in capital—Common 30,000

Retained earnings 70,000

Total stockholders’ equity $150,000Assume Shah Company declares a 10% stock dividend;

500 shares @ $40 per share market value

Before Dividend

Small Stock Dividend Example

Stockholders’ Equity: Common stock, $10 par, 5,500 shares $ 50,000 $ 55,000Additional paid-in capital—Common 30,000 45,000Retained earnings 70,000 50,000

Total stockholders’ equity $150,000 $150,000

$40 market value deducted from retained earnings; allocated between Common Stock (initially Common

Stock Dividend Distributable) andAdditional Paid-in Capital.

Before After

Small Stock Dividend Example

++–

Stockholders’ Equity: Common stock, $10 par, 5,500 shares $ 50,000 $ 55,000Additional paid-in capital—Common 30,000 45,000Retained earnings 70,000 50,000

Total stockholders’ equity $150,000 $150,000

Before After

Small Stock Dividend Example

++–

Total S/E is unchanged

Stockholders’ Equity:Common stock, $10 par, 5,000 shares

issued and outstanding $ 50,000Additional paid-in capital—Common 30,000

Retained earnings 70,000

Total stockholders’ equity $150,000

Assume Shah Company declares 100% stock dividend

Before Dividend

Large Stock Dividend Example

Stockholders’ Equity: Common stock, $10 par, 10,000 shares $ 50,000 $100,000Additional paid-in capital—Common 30,000 30,000Retained earnings 70,000 20,000

Total stockholders’ equity $150,000 $150,000

Dividend deducted from retained earnings and recorded in the Common Stock account at par. Additional Paid-in Capital account is unaffected.

Before After

Large Stock Dividend Example

+–

Stockholders’ Equity: Common stock, $10 par, 10,000 shares $ 50,000 $100,000Additional paid-in capital—Common 30,000 30,000Retained earnings 70,000 20,000

Total stockholders’ equity $150,000 $150,000

Before After

Large Stock Dividend Example

+–

Total S/E is unchanged

Stock SplitsResults in additional issuance of

sharesReduces par value per shareNo change in Stockholders’ Equity

accounts

LO 7

Stock SplitsNot recorded in accounts

Reduce market price per share and make the stock more accessible to a wider range of investors

Disclosed in notes

Stockholders’ Equity:Common stock, $10 par, 5,000 shares

issued and outstanding $ 50,000Additional paid-in capital—Common 30,000

Retained earnings 70,000

Total stockholders’ equity $150,000Assume Shah Company declares 2-for-1 stock split

Before Split

2-for-1 Stock Split Example

Stockholders’ Equity: Common stock, $5 par, 10,000 shares $ 50,000 $ 50,000Additional paid-in capital—Common 30,000 30,000Retained earnings 70,000 70,000

Total stockholders’ equity $150,000 $150,000

Before After

2-for-1 Stock Split Example

All accounts are unchangedOnly disclosures

are affected

Statement of Stockholders’ Equity

Explains all the reasons for the difference between the beginning and the ending balance of each of the accounts in the Stockholders’ Equity category of the balance sheet

Statement of Retained EarningsBeginning retained earnings

Add: Net earningsSubtract: Dividend(s) declared = Ending retained earnings

LO8

Income StatementFor Year Ended December 31, 20XX

Revenues xxxExpenses xxxOther gains and losses xxxIncome before tax xxxIncome tax expense xxxNet income xxx

Statement of Comprehensive Income

Statement of Comprehensive IncomeFor Year Ended December 31, 20XX

Net income xxxForeign currency translation adjustment xxxUnrealized holding gains/losses xxxMinimum pension liability adjustment xxxOther comprehensive income xxxComprehensive income xxx

Comprehensive income: The total change in net assets from all sources except investments by or distributions to the owners

Analyzing Stockholders’ EquityBook value per share

• Rights that each share of common stock has to the net assets of corporation

Market value per share • Price at which stock is currently

selling

LO9

Book Value per Share

Amount per share of net assets to which the company’s common stockholders have the rights

Does not indicate the price that should be paid by those who want to buy or sell the stock on the stock exchange

Total Stockholders’ Equity Number of Shares of Stock Outstanding

Market Value per Share The selling price of the stock as indicated

by the most recent transactions Usually stated in a 52-week high and low More meaningful measure of the value of

the stock than book value

52-week Daily

High Low Sym High Low Last Change

68.17 39.17 GM 43.3 42.01 42.93 +0.48 (1.13%)

Stockholders’ Equity Items on the Statement of Cash FlowsOperating Activities Net income xxx Investing Activities Financing Activities Issuance of stock +

Retirement or repurchase of stock – Payment of dividends –

LO10

AppendixAccounting Tools:

Unincorporated Businesses

Sole Proprietorships Not a separate legal entity so owner has

unlimited liability Must keep personal and business records

separate Business income is declared on the owner’s

personal tax return and taxed at personal tax rate

LO11

Sole ProprietorshipsOwner’s withdrawal of an auto from the business:

Peter Tom, Drawing 6,000Equipment 6,000

To record the withdrawal of an auto from the business.

Owners’ drawing or withdrawal accounts are contra-equity accounts

Sole Proprietorships Drawing or withdrawal and income summary

accounts are closed to the owner’s capital account

Owner’s Equity section of the balance sheet consists of the capital account:

Beginning balance $ 0Plus: Investments 10,000

Net Income 4,000Less: Withdrawals (6,000)Ending balance $ 8,000

PartnershipsUnlimited liabilityLimited life—partnership

agreements can and do endNot taxed as a separate entity

PartnershipsDistribution of income: Equal distribution Stated ratio Other allocation

• For example, based on salaries, interest on invested capital, and a stated ratio

End of Chapter 11