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9-1
Stockholders’ Equity
Chapter 9
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9-2
Learning Objective 1
Explain the features of a corporation
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9-3
Characteristics of a CorporationSeparate Legal Entity
Corporation distinct from owners; artificial person
Continuous Life/Transfer of Ownership: Company continues to exist & operate regardless of
ownership changes
Separation of Ownership & Management: Stockholders
elect Board of Directors who, in turn, appoint officers
Limited LiabilityStockholders are not personally
liable for corporate debts
Corporate TaxationCorporations are taxed on their earnings; dividends distributed
to owners are also taxed
Government RegulationCorporate activities are
monitored by governmentregulations
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Organizing a Corporation
• Incorporators Organize the corporation Pay fees Sign charter File documents with the state Agree to bylaws
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Authority Structure in a CorporationStockholders
Board of Directors
Chair of the Board (CEO)
President (Chief Operating Officer)
Vice Presidents and other corporate officers whoManage the day-to-day operations
Elect the
which elects the
and the
who leads
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Stockholders’ Rights
• Vote at stockholder meetings
• Receive dividends
• Receive share if corporation liquidates
• Maintain proportionate ownership Preemptive right
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Parts of Stockholders’ Equity
• Paid-in capital Represents amounts contributed by
stockholders Include stock accounts
• Retained earnings Amounts earned and kept by the corporation
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9-8
Classes of Stock
Common• Basic form of
common stock• Have rights of
ownership• Benefit most of
company succeeds• Risk most if company
does not succeed
Preferred• Have preference in
receiving dividends and assets in case of liquidation
• Hybrid between common stock and debt
• Rare for corporations to issue
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9-9
Classes of Stock
Par value• Arbitrary amount
assigned to share of stock
• In most states, represents minimum price for shares Legal capital
No-par• Does not have a par
value• May have a stated
value
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9-10
Learning Objective 2
Account for the issuance of stock
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9-11
Issuing Common Stock at Par
• A company issues 100,000 shares of $5 par value common stock at par
• The common stock account is always credited in the amount of the shares issued multiplied by par value
Date Accounts Debit Credit
Cash $500,000
Common stock $500,000
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9-12
Issuing Common Stock Above Par
• A company issues $100,000 shares of $5 par value stock for $12 per share
• The amount above par is credited to Paid-in Capital in Excess of Par
Date Accounts Debit Credit
Cash $1,200,000
Common stock $500,000
Paid-in capital in excess of par ________
(100,000 shs x $5 par)
(100,000 shs x $12 price)
What amount will make the
entry balance?
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9-13
Issuing Common Stock for Noncash Assets
• Assets recorded at their fair values• Common stock and paid-in capital credited accordingly• Suppose a company purchased equipment valued at
$800,000 by issuing 50,000 shares of its $5 par common stock
Date Accounts Debit Credit
Equipment _________
Common stock _________
Paid-in capital in excess of par $550,000
Fair value of equipment
Shares issued x par value
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Preferred Stock
• Follows the same pattern as common stock entries Preferred stock is credited for the shares
issued multiplied by the par value A separate paid-in capital account is used if
stock is issued above par
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Authorized, Issued and Outstanding
• Authorized – maximum number of shares company can issue as indicated in its charter
• Issued – number of shares company has sold to shareholders
• Outstanding – number of shares currently in shareholders’ possession Any difference between issued and
outstanding is due to treasury stock
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Learning Objective 3
Describe how treasury stock affects a company
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Treasury Stock
• Company’s own stock that it has issued and later reacquired
• Reasons: All authorized shares have been issued and
shares are needed for employee stock purchase plans
Company wants to purchase its shares at a low price and the re-issue them at a higher price
Management want to avoid a takeover
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Accounting for Treasury Stock
• Recorded at cost (not par value)
• Contra-equity account (debit balance)
• Reduces stockholders’ equity and assets
• If sold above, paid-in capital from treasury stock transactions is credited
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Accounting for Treasury Stock
• Suppose a company purchased 10,000 shares of its own $1 par common stock for $200,000
Date Accounts Debit Credit
Treasury stock $200,000
Cash $200,000
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Accounting for Treasury Stock
• Later, the company resells the treasury shares for $250,000
Date Accounts Debit Credit
Cash $250,000
Treasury stock _________
Paid-in capital from treasury stock
transactions $50,000
Amount company paid to buy shares
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Retained Earnings
• Balance = Net incomes – net losses – dividends declared
• Accumulated earnings the company keeps
• Not a reservoir of cash
• Normal credit balance
• Debit balance = Deficit Losses and dividends exceed earnings
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Learning Objective 4
Account for dividends
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Dividends
• Distribution to stockholders
• Three forms Cash Stock Noncash assets
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Cash Dividends
• Company must have both: Enough Retained Earnings to declare the
dividend Enough Cash to pay the dividend
• Board of Directors has authority to declare the dividend
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Dividend Dates
• Date of Declaration Board of Directors announces dividend Corporation is now obligated to pay
• Date of record Stockholders who own shares on this date will
receive dividend
• Date of payment Payment sent to shareholders on record
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Accounting for Dividends
• Date of Declaration
Accounts Debit Credit
Retained Earnings $$$$$
Dividends Payable $$$$$
Equity Decreases; Liabilities Increase
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Accounting for Dividends
• Date of Record – no entry• Date of Payment
Accounts Debit Credit
Dividends Payable $$$$$
Cash $$$$$
Liabilities Decrease; Assets Decrease
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Retained Earnings
Beginning Balance
Dividends Declared
Ending Balance
Net Income
If retained earnings increases, net income > dividends
If retained earnings decreases, net income < dividends
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Preferred Dividends
• Preferred shareholders receive dividends before common shareholders
• Dividend rate expressed as: Percent of par value Dollar amount per share
• Cumulative – any unpaid dividends are carried forward until paid Dividends in arrears
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Preferred Dividend Example
• A corporation has 10,000 shares of $100, 8% cumulative preferred stock outstanding
• It also has 80,000 shares of $1 par common stock outstanding
• The Board of Directors declares dividends as follows: Year 1 = $ 20,000 Year 2 = $150,000
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Preferred Dividend Example
Preferred Dividend : 10,000 shares x $100 par x 8% = $80,000
Preferred Common
Year 1 $20,000 $ -
Year 2
Dividends in arrears $60,000
Current year $80,000
$140,000 $10,000
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Stock Dividends
• Proportional distribution of shares to stockholders
• Reasons corporations distribute stock dividends: Provide dividend, yet conserve cash Reduce market price of shares
• Decrease retained earnings and increase common stock Total equity is unchanged
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Stock Dividends
• Small Less than 25% of outstanding shares Recorded at market value
• Large Greater than 25% of outstanding shares Recorded at par value
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E9-27
• 10% stock dividend – small: recorded at market value 10% x 500,000 shares issued = 50,000 Market value = $17 per share
Accounts Debit Credit
Retained Earnings __________
Common stock ___________
Paid-in capital in excess of par $845,000
Shares issued x market value
Shares issued x par
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E9-27
Stockholders' Equity
Common stock, $0.10 par, 2,000,000 shares
authorized, ___________shares outstanding $55,000
Paid-in capital in excess of par $1,807,000
Retained earnings $6,272,000
Other ($195,000)
Total stockholders' equity $7,939,000
Increase by shares in
stock dividends
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Stock Splits
• Increase in shares coupled with a proportionate reduction in par value 2-for-1 split doubles the shares outstanding
and halves the par value
• No entry made Description of stock changed on balance
sheet
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Assets = Liabilities + Equity
Issue stock Increase No effect Increase
Purchase treasury stock Decrease No effect Decrease
Sell treasury stock Increase No effect Increase
Declare cash dividend No effect Increase Decrease
Pay cash dividend Decrease Decrease No effect
Stock dividend No effect No effect No effect
Stock split No effect No effect No effect
Summary of Transaction Effects
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Learning Objective 5
Use stock values in decision making
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Stock Value TermsPrice one can buy or sell one share of
stock for; varies with company performance and economy
Redemption value Set price company is required to pay toretire preferred stock
Liquidation value Required payment to preferred shareholders if the company liquidates
Book value Common equity# of common shares outstanding
Market value
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Learning Objective 6
Compute return on assets and return on equity
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Return on Assets (ROA)
• Measures company’s use of assets to earn income for financers of the business Creditors Stockholders
Net income + Interest expense
Average total assets
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Return on Equity (ROE)
• Shows relationship between net income and equity Computed only on common stock
• Should be higher than return on assets Stockholders risk more than bondholders
Net income – Preferred dividends
Average common stockholders’ equity
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Learning Objective 7
Report equity transactions on the statement of cash flows
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Equity Transactions on the Cash Flow Statement
• All equity transactions are financing activities
• Financing inflow Issuing stock
• Financing outflow Purchase of treasury stock Payment of dividends
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End of Chapter 9
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