Spiceland Chapter 18Copyright © 2007 by The McGraw-Hill Companies,
Inc. All rights reserved.
Shareholders’ Equity
Learning Objectives
Describe the components of shareholders’ equity and explain how
they are reported in a statement of shareholders’ equity.
Our first learning objective in Chapter 18 is to describe the
components of shareholders’ equity and explain how they are
reported in a statement of shareholders’ equity.
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Assets – Liabilities = Shareholders’ Equity
Net Assets
(Residual Interest)
Shareholders’ equity accounts represent the ownership interests of
the shareholders in a corporation. From the balance sheet, total
shareholders’ equity equals total assets minus total liabilities.
Another way to think about shareholders’ equity is that it
represents the portion of a corporation’s assets that have been
financed by the owners as opposed to that portion that has been
financed by creditors..
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Part I.
Corporations have two primary sources of equity. The first is
paid-in capital representing amounts that shareholders have
invested by buying shares of stock from the company.
Part II.
The second source of equity is retained earnings. The retained
earnings account reports the cumulative amount of net income the
corporation has earned since its organization less the cumulative
amount of dividends declared since organization. This is the
portion of the net income that has been reinvested in the business
rather than distributed to the owners in dividends.
Part III.
Accumulated other comprehensive income includes all changes in
equity except those resulting from investments by owners and
distributions to owners.
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Double taxation.
Government regulation.
The corporate form of organization has several advantages. The
major advantage is the ease of raising large amounts of money
because both large and small investors can participate in corporate
ownership. In addition, corporate owners can transfer ownership
rights very easily. Stockholders are generally free to buy and sell
shares of common stock to others without permission from the
corporation. Organized exchanges, such as the New York Stock
Exchange, maintain markets in which shares in thousands of
companies are bought and sold each business day. Stockholders’
losses are limited to the amount invested in the corporation.
Corporate creditors cannot make claims on the personal assets of
shareholders to satisfy corporate debt. Corporations are a separate
legal entity that can enter into contracts and sue and be sued. The
corporation continues in existence even when ownership
changes.
Corporations also have some disadvantages. Corporations pay taxes
on their earnings and then if they distribute a dividend to
stockholders, the stockholders pay taxes on the dividends received.
This is sometimes referred to as double taxation. Corporations are
subject to many laws and regulations Large, publicly traded
corporations are much more heavily regulated than smaller closely
held corporations. They are subject to the provisions of the
Securities and Exchange Commission Acts of 1933 and 1934, the
Sarbanes-Oxley Act of 2002, and various exchange listing
requirements.
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only a few individuals.
There are two basic types of corporations:
Not-for-profit corporations include hospitals, charities and
government
agencies such as Federal Deposit Insurance Corporation.
For-profit corporations that may be either:
Publicly-held corporations whose shares are widely owned by
the
general public, or .
Privately-held corporations whose shares are owned by only a
few
individuals.
Our primary focus in this chapter is on corporations formed for the
purpose of generating profits.
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Maximum number of owners.
All owners may be involved in management
without losing limited liability protection.
No limit on number of owners.
Limited liability partnership
Owners are liable for their own actions but not entirely liable for
actions of other partners.
Double
taxation
avoided.
A corporation can elect to comply with specific tax rules and be
designated an S corporation. Owners of S corporations have limited
liability, but income and expenses are passed through to the
owners, thereby avoiding double taxation. The number of owners of
an S corporation is limited by law.
Owners of a limited liability company are not liable for the debts
of the business except to the extent of their investment. All
owners can be involved in the management of the company without
losing their limited liability. Income and expenses are passed
through to the owners so double taxation is avoided. Unlike an S
corporation, there are no limits to the number of owners of a
limited liability company.
A limited liability partnership is similar to a limited liability
company except it doesn’t provide all of the liability protection.
Owners are liable for their own actions but not entirely liable for
the actions of other owners.
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Number and classes
of shares authorized.
Composition of initial
board of directors.
Nature and location
of business activities.
A corporate charter is granted by the state in which a business
incorporates. The corporate charter describes the nature of the
firm’s business, the number and classes of shares authorized to be
issued, and the composition of the initial board of
directors.
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Board of directors
corporate charter.
The requirements for forming a corporation are determined by the
laws of the state where the business is incorporated. The Articles
of Incorporation is the application for corporate status. Once
granted a charter by the state, the corporation can issue shares of
stock to investors. The stockholders of a corporation elect the
members of the board of directors. In turn, the members of the
board of directors hire the executive officers of the corporation.
Finally, officers of the corporation empower others to hire needed
employees. Employees, officers, and member of the board of
directors may also be shareholders of the corporation
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percentage
ownership.
In addition to the right to buy and sells shares of stock,
shareholders have the right to vote at the annual meeting of
stockholders. Besides electing members of the board of directors,
shareholders often vote on other issues of importance to the
operations of the company. Shareholders receive dividends declared
by the board of directors. In the event of liquidation, they share
equally in any remaining assets after creditors are paid.
Shareholders may also have the preemptive right to maintain their
percentage ownership when new shares are issued.
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Authorized, Issued, and Outstanding Capital Stock
The maximum number of shares of capital stock that can be sold to
the public is called the authorized number of shares.
Authorized
Shares
Authorized shares are the maximum number of shares of stock that
can be sold to the public. The number of authorized shares is
identified in the corporation’s charter that is issued by the state
of incorporation.
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Authorized, Issued, and Outstanding Capital Stock
Issued shares are authorized shares of stock that have been
sold.
Unissued shares are authorized shares of stock that have never been
sold.
Authorized
Shares
Seldom are all of the authorized shares sold to investors, so
authorized shares are either issued or unissued. Issued shares are
shares of stock that have been sold to investors at some point.
Unissued shares are shares of stock that have never been sold to
investors.
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Unissued
Shares
Treasury
Shares
Outstanding
Shares
Treasury shares are issued shares that have been reacquired by the
corporation.
Issued
Shares
Outstanding shares are issued shares that are owned by
shareholders.
Authorized
Shares
Issued shares can be classified as either outstanding shares or
treasury shares. Outstanding shares are shares that are currently
owned by shareholders. Treasury shares are shares that were once
owned by shareholders but the corporation has repurchased the
shares in the open market. After repurchase, the corporation is the
owner of those shares.
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Unissued
Shares
Retired
Shares
Outstanding
Shares
Retired shares assume the same status as authorized but unissued
shares.
Outstanding shares are issued shares that are owned by
stockholders.
Authorized
Shares
When a corporation retires its reacquired shares (treasury shares),
those shares assume the same status as authorized but unissued
shares, just as if they had never been issued.
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Designated dollar amount per share stated in the corporate
charter.
Par value has no relationship to market value.
No-par stock
Dollar amount per share not designated in corporate charter.
Corporations can assign a stated value per share (treated as if par
value).
Common stock normally has a par value which is usually a very small
amount, typically less than one dollar per share. In states that
require a par value per share, the par value is also the legal
capital that must remain invested in the business. Par value is an
arbitrary amount assigned to each share of stock in the corporate
charter, and it is not related in any manner to market value, which
is the selling price of a share of stock.
In addition to par value stock, some states permit no-par value
common stock. Some states permit no-par, stated value common stock.
In those states, the stated value is treated just like the par
value.
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Legal capital is . . .
The portion of shareholders’ equity that must be contributed to the
firm when stock is issued.
The amount of capital, required by
state law, that must remain invested
in the business.
or full amount paid for no-par stock.
In states that require a par value or stated value per share, the
par value or stated capital is also the legal capital. Legal
capital is outdated concept that refers to:
The portion of shareholders’ equity that must be contributed to the
firm when
stock is issued.
The amount of capital, required by state law, that must remain
invested in the
business.
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Common
Preferred
There are two basic types of capital stock: common stock and
preferred stock.
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Ranks after preferred stock for dividend and liquidation
distribution.
Dividends determined by the board of directors.
Common stock is the basic voting stock of the corporation. It
represents the residual claim on assets in liquidation. Dividends
paid must first satisfy preferred stock agreements before any
distribution can be made to common stockholders.
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redeemable.
Preferred stock is a separate class of stock that typically has
priority over common stock in dividend distributions and
distribution of assets in a liquidation. It normally does not have
voting rights and is often callable by the corporation at a stated
value. Some preferred stock issues have an additional preference to
be converted into common stock at the stockholder’s choice.
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Preferred Stock Dividends
Are usually stated as a percentage of the par or stated
value.
May be cumulative or noncumulative.
May be partially participating, fully participating, or
nonparticipating.
Preferred stock usually has a stated dividend that is expressed as
a percentage of its par value. Cumulative preferred stock has the
right to be paid both the current and all prior periods’ unpaid
dividends before any dividends are paid to common
stockholders.
Noncumulative preferred stock has no rights to prior periods’
dividends if they were not declared in those prior periods. Most
preferred stock is cumulative.
Preferred shares may also participate in dividends beyond the
stated amount. Partially participating preferred shares have a
limit on the amount of additional dividends. Fully participating
preferred shares receive a pro rata share of all dividends declared
based on the relative par value amounts of common and preferred
shares outstanding. Most preferred stock is nonparticipating.
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Cumulative
Unpaid dividends must be paid in full before any distributions to
common stock.
Dividends in arrears are not liabilities, but the per share and
aggregate amounts must be disclosed.
When the preferred stock is cumulative and the directors do not
declare a dividend to preferred stockholders, the unpaid dividend
is called a dividend in arrears. All dividends in arrears on
cumulative preferred stock must be paid in full before any
dividends can be paid to common stockholders. Dividends in arrears
are not liabilities because they have not been declared. However,
the per share and aggregate amounts of dividends in arrears must be
disclosed.
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Describe comprehensive income and its components.
Our second learning objective in Chapter 18 is to describe
comprehensive income and its components.
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of gains and losses that traditionally have
been excluded from net income.
Net holding gains (losses) on investments.
Deferred gains (losses) from derivatives.
Net unrecognized loss on pensions.
Gains (losses) from foreign currency translations.
Comprehensive income is the total change in equity excluding only
transactions with owners. Typical transactions with owners are
dividends and the sale or repurchase of shares.
Comprehensive income starts with net income and adds or subtracts
certain unrealized gains and losses that are not reported on the
income statement. Comprehensive income includes four types of gains
and losses that traditionally have been excluded from net
income:
Net holding gains (losses) on investments.
Net unrecognized loss on pensions.
Gains (losses) from foreign currency translations.
Deferred gains (losses) from derivatives.
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($ in millions)
Net income $xxx
Other comprehensive income:
Net unrealized holding gains (losses) on investments (net of tax)†
$ x
Net unrecognized loss on pensions (net of tax)‡ (x)
Deferred gains (losses) from derivatives (net of tax)§ x
Gains (losses) from foreign currency translation (net of tax)* x
xx
Comprehensive income $xxx
‡ Reporting a pension liability sometimes requires recording this
(described in Chapter 17). It often is called pension liability
adjustment.
§ When a derivative designated as a cash flow hedge is adjusted to
fair value, the gain or loss is deferred as a component of
comprehensive income and included in earnings later, at the same
time as earnings are affected by the hedged transaction (described
in the Derivatives Appendix to the text).
* Gains or losses from changes in foreign currency exchange rates.
The amount could be an addition to or reduction in shareholders’
equity. (This item is discussed elsewhere in your accounting
curriculum.)
In the upper half of your screen you see an illustration of how
comprehensive income, created during the current period, is
reported. We start with net income and add or subtract the four
types of gains and losses that traditionally have been excluded
from net income to arrive at comprehensive income.
The information on the lower half of your screen provides some
detail about the four items included in comprehensive income.
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Comprehensive Income
Comprehensive income is reported periodically as it is created and
also is reported as a cumulative amount.
There are 3 options for reporting comprehensive income created
during the reporting period.
The accumulated amount of comprehensive income is reported as a
separate item of shareholders’ equity in the balance sheet.
As a separate statement in
a disclosure note.
Part I.
Comprehensive income is reported periodically as it is created and
also is reported as a cumulative amount.
Part II.
There are 3 options for reporting comprehensive income created
during the reporting period.
As an additional section of the income statement.
As part of the statement of shareholders’ equity.
As a separate statement in a disclosure note.
Part III.
The accumulated amount of comprehensive income is reported with
retained earnings.
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Learning Objectives
Record the issuance of shares when sold for cash, for noncash
consideration, and by share purchase contract.
Our third Learning objective in Chapter 18 is to record the
issuance of shares when sold for cash, for noncash consideration,
and by share purchase contract.
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Issuing Stock for Cash
10,000 shares of $1 par value stock is issued for $100,000
cash.
When shares of par value stock are issued for cash, we debit cash
for the proceeds, credit common stock for the par value of the
shares issued, and credit paid-in-capital in excess of par for the
difference between the cash proceeds and the par value.
JAB
10,000 shares of no-par stock is issued for $100,000 cash.
When shares of no-par stock are issued for cash, we debit cash and
credit common stock for the proceeds.
JAB
Issuing Stock for Cash
10,000 shares of no-par stock, with a stated value of $1 is issued
for $100,000 cash.
When shares of no-par stock with a stated value are issued for
cash, we debit cash for the proceeds, credit common stock for the
stated value of the shares issued, and credit paid-in-capital in
excess of stated value for the difference between the cash proceeds
and the stated value.
JAB
Stated Value, Common Stock
Issuing Stock for Noncash Assets
Apply the general valuation principle by using fair value of stock
given up or fair value of asset received, whichever is more clearly
evident.
If market values cannot be determined, use appraised values.
When shares of stock are issued in exchange for noncash assets, we
apply the general valuation principle we have seen in previous
chapters. The transaction is valued at the fair value of stock
issued or the fair value of asset received, whichever is more
clearly evident. If the stock is actively traded on an exchange, we
have an objective value to use for the transaction.
If fair values cannot be determined, then we must use appraised
values.
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for a Single Price
Allocate the lump-sum received based on the relative fair values of
the two securities.
If only one fair value is known, allocate a portion of the lump-sum
received based on that fair value and allocate the remainder to the
other security.
If more than class of shares is issued for a single price, we must
allocate the lump-sum received based on the relative fair values of
the two securities.
If only one fair value is known, we allocate a portion of the
lump-sum received based on that fair value and allocate the
remainder to the other security.
Let’s look at an example.
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for a Single Price
Toys, Inc. issued 5,000 shares of common stock, $10 par value and
3,000 shares of preferred stock, $5 par value for $450,000. The
market values of the common stock and preferred stock were $55 and
$75, respectively.
Calculate the additional paid-in
capital for each class of stock.
Toys, Inc. issued 5,000 shares of common stock, $10 par value and
3,000 shares of preferred stock, $5 par value for $450,000. The
market values of the common stock and preferred stock were $55 and
$75, respectively.
Calculate the additional paid-in capital for each class of
stock.
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for a Single Price
Record the journal entry for issuing the stock.
First we calculate the total market values of the shares issued by
multiplying the market value per share times the number of shares
issued. For common stock, 5,000 shares times $55 per share equals
$275,000, and for preferred stock, 3,000 shares times $75 per share
equals $225,000, and the sum of these two amounts gives us a total
market value of $500,000.
Next we divide the market value of each class of stock by the total
market value of $500,000 to get the allocation percentages. For
common stock, $275,000 divided by $500,000 equals 55 percent, and
for preferred stock $225,000 divided by $500,000 equals 45
percent.
We multiply the allocation percentages times the $450,000 received
to allocate the proceeds to each class of stock. For common stock,
55 percent of $450,000 is $247,500, and for preferred stock, 45
percent of $450,000 is $202,500.
Finally we subtract the total par value of each class of stock from
the allocated amounts. For common 5,000 shares times $10 par value
per share equals $50,000, and for preferred, 3,000 shares times $5
par value per share equals $15,000. The additional paid-in capital
for common is $247,500 minus $50,000, or $197,500. The additional
paid-in capital for preferred is $202,500 minus $15,000, or
$187,500.
Now let’s record this transaction with a journal entry.
Sheet: Sheet1
Sheet: Sheet2
Sheet: Sheet3
Sheet: Sheet4
Sheet: Sheet5
Sheet: Sheet6
Sheet: Sheet7
Sheet: Sheet8
Sheet: Sheet9
Sheet: Sheet10
Sheet: Sheet11
Sheet: Sheet12
Sheet: Sheet13
Sheet: Sheet14
Sheet: Sheet15
Sheet: Sheet16
for a Single Price
We debit cash for the proceeds of $450,000. We credit common stock
for its $50,000 par value and we credit preferred stock for its
$15,000 par value. Then we credit additional paid-in capital for
the two classes of stock, $197,500 for common and $187,500 for
preferred.
JAB
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from selling shares, resulting in a lower
amount of additional paid-in capital.
Registration fees
Underwriter commissions
Promotional costs
When a company sells its shares to the public, it incurs certain
costs called share issue costs. The costs include:
Registration fees
Underwriter commissions
Promotional costs
Share issue costs reduce net proceeds from selling shares,
resulting in a lower
amount of additional paid-in capital.
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Dow Industrial sold 100,000 shares of its
$1 par value stock for $10 using a share
purchase contract. Forty percent of the sale
price was collected at sale and sixty
percent will be received in six months.
Prepare the journal entry for this transaction.
A share purchase contract is an agreement between a corporation and
a subscriber whereby shares are sold in exchange for a promissory
note. Normally corporations issue shares through investment bankers
and brokerage firms, who then sell the shares to the public, but
occasionally, share purchase contracts might be used. Consider the
following example:
Dow Industrial sold 100,000 shares of its $1 par value stock for
$10 using a share purchase contract. Forty percent of the sale
price was collected at sale and sixty percent will be received in
six months.
Prepare the journal entry for this transaction.
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It is reported as reduction in paid-in capital.
The total sale price of the shares is $1,000,000, calculated by
multiplying 100,000 shares times the $10 per share sale price. We
debit cash for $400,000 which is forty percent of the sale price
that was collected at sale. We record the remaining sixty percent
that will be collected in six months with a debit to receivable
from share purchase contract for $600,000. We credit common stock
for the $100,000 of par value and additional paid-in capital for
the remainder of the issue price.
The $600,000 receivable from share purchase contract is not an
asset. It is reported as reduction in paid-in capital.
JAB
600,000
reacquiring
shares.
Now that we have discussed issuing shares, let’s turn our attention
to reacquiring shares.
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Support the market price.
Increase earnings per share.
Thwart takeover attempts.
A corporation might reacquire shares of its stock for a number of
reasons including:
Supporting the market price.
Increasing earnings per share.
To thwart takeover attempts.
holding them as
treasury shares.
Regardless of the reasons for repurchasing shares of stock,
companies can account for the repurchase in either of the follow
ways:
The shares can be formally retired, or
They can be accounted for as treasury shares.
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Learning Objectives
Describe what occurs when shares are retired and how retirement is
recorded.
Our fourth learning objective in Chapter 18 is to describe what
occurs when shares are retired and how retirement is
recorded.
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Accounting for Retired Shares
When shares are formally retired, we reduce the same capital
accounts that were increased when the shares were issued – common
or preferred stock, and additional paid-in capital.
When shares are formally retired, we reduce the same capital
accounts that were increased when the shares were issued – common
or preferred stock, and additional paid-in capital.
Consider the following example.
Accounting for Retired Shares
5,000 shares of $2 par value stock that were issued for $20 per
share are reacquired for $17 per share.
Price paid is less than issue price.
First, let’s examine the case where the price paid to reacquire the
shares is less than the original issue price.
The company pays $17 per share to reacquire 5,000 shares of $2 par
value stock, that were originally issued for $20 per share.
We record this transaction by reducing common stock with a $10,000
debit for its par value, and by reducing paid-in capital in excess
of par with a debit of $90,000. We credit cash for the amount paid,
5,000 shares times $17 per share equals $85,000. Finally, we credit
paid in capital-share repurchase for $15,000, the difference
between the $100,000 of proceeds from the original and the $85,000
paid to reacquire the shares.
JAB
90,000
Accounting for Retired Shares
5,000 shares of $2 par value stock that were issued for $20 per
share are reacquired for $25 per share.
Price paid is more than issue price.
Reduce Retained Earnings if the
Paid-in Capital – Share Repurchase
account balance is insufficient.
Part I.
Now let’s examine the case where the price paid to reacquire the
shares is more than the original issue price.
The company pays $25 per share to reacquire 5,000 shares of $2 par
value stock, that were originally issued for $20 per share.
We record this transaction by reducing common stock with a $10,000
debit for its par value, and by reducing paid-in capital in excess
of par with a debit of $90,000, the same entries as in the first
case. We credit cash for the amount paid, 5,000 shares times $25
per share equals $125,000. Finally, we debit paid in capital-share
repurchase for $25,000, the difference between the $100,000 of
proceeds from the original and the $125,000 paid to reacquire the
shares. The $25,000 debit to paid in capital-share repurchase
assumes that a credit balance of at least $25,000 already exists in
this account.
Part II.
If the credit balance is less than $25,000, we would debit retained
earnings for the amount needed.
JAB
90,000
Distinguish between accounting for retired shares and for treasury
shares.
Our fifth learning objective in Chapter 18 is to distinguish
between accounting for retired shares and for treasury
shares.
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shareholders’ equity.
Treasury stock has no voting or dividend rights. Dividends are not
paid on treasury stock, and a corporation holding its own stock
cannot vote the shares at the annual meeting. In the event of
liquidation, the corporation receives no portion of the liquidated
assets for the shares that it holds in the treasury.
Treasury stock is not an asset. The purchase of treasury stock
reduces assets by the amount paid for the purchase. It is reported
in the shareholders’ equity portion of the balance sheet as a
reduction from total equity.
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Resale of Treasury Stock
Difference between cost and
issuance price is (generally)
recorded in paid-in capital –
share repurchase.
Using the cost method, we record (debit) treasury stock for the
cost to purchase it. The total cost of all shares of treasury stock
held by the company is the amount reported as a reduction in
stockholders’ equity.
If the treasury stock is reissued, any difference between cost and
issuance price is (generally) recorded in paid-in capital – share
repurchase.
Let’s look at an example.
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Accounting for Treasury Stock
On 5/1/05, Photos-in-a-Second reacquired 3,000 shares of its common
stock at $55 per share. On 12/3/06, Photos-in-a-Second reissued
1,000 shares of the stock at $75 per share. Which of the following
would be included in the 12/3 entry?
a. Credit Cash for $165,000.
b. Debit Treasury Stock for $75,000.
c. Credit Treasury Stock for $55,000.
d. Credit Cash for $75,000.
On May 1, 2005 Photos-in-a-Second reacquired 3,000 shares of its
common stock at a cost of $55 per share. On December 3, 2006,
Photos-in-a-Second reissued 1,000 shares of the stock at price of
$75 per share.
Would the reissue entry on December 3, 2006 include credit to cash
for $165,000; a debit to treasury stock for $75,000; a credit to
treasury stock for $55,000; or a credit to cash for $75,000?
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Accounting for Treasury Stock
On 5/1/05, Photos-in-a-Second reacquired 3,000 shares of its common
stock at $55 per share. On 12/3/06, Photos-in-a-Second reissued
1,000 shares of the stock at $75 per share. Which of the following
would be included in the 12/3 entry?
a. Credit Cash for $165,000.
b. Debit Treasury Stock for $75,000.
c. Credit Treasury Stock for $55,000.
d. Credit Cash for $75,000.
Solution
The correct answer is choice c. Let’s look at the entries for these
two transactions to help us arrive at the correct answer to the
question.
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Accounting for Treasury Stock
The cost of the treasury stock purchase is $165,000, calculated by
multiplying 3,000 shares times $55 per share. The entry on May 1,
2005 requires a debit to treasury stock and a credit to cash for
$165,000 for the cost of the purchase.
The proceeds of the sale are $75,000 calculated by multiplying
1,000 shares times $75 per share. The entry on December 3, 2006
requires debit to cash for $75,000; a credit treasury stock is for
$55,000, the cost of 1,000 shares at $55 per share; and a $20,000
credit to paid-in capital – share repurchase for the difference
between the reissue price and the cost of the treasury stock.
JAB
Dec. 3, 2006
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Equity.
The cost of treasury stock is reported as an unallocated reduction
of total shareholders’ equity. In our example, Photos-in-a-Second
would report an ending balance in its treasury stock account of
$110,000 as a reduction is its shareholders’ equity. The $110,000
treasury stock balance results from the original debit entry for
$165,000 less the credit entry for the sale for $55,000.
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it from paid-in-capital.
Our sixth learning objective in Chapter 18 is to describe retained
earnings and distinguish it from paid-in-capital.
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Represents the undistributed earnings of the company since its
inception.
Represents the undistributed earnings of the company since its
inception. The most frequent changes to retained earnings are
increases due to income and decreases due to distributions to
owners, primarily dividends.
Sheet1
Retained Earnings
The statement of retained earnings may also contain the correction
of an accounting error that occurred in the financial statements of
a prior period, called a prior period adjustment.
Any restrictions on retained earnings
must be disclosed in the notes to the financial statements.
The statement of retained earnings may also contain the correction
of an accounting error that occurred in the financial statements of
a prior period, called a prior period adjustment. Some loan
agreements place restrictions on the amount of dividends that can
be paid based on the balance in retained earnings. Restrictions on
retained earnings are generally disclosed in the notes to the
financial statements.
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Section of a Balance Sheet
Here is an example of a shareholders’ equity section of a balance
sheet. Notice that it reports both common and preferred stock at
par value, additional paid-in capital for both common and preferred
stock, and retained earnings.
Sheet1
authorized; 20,000 shares issued and
outstanding
$ 200,000
authorized; 400 shares issued and
outstanding
40,000
300,000
10,000
Explain the basis of corporate dividends, including the
similarities and differences between cash and property
dividends.
Our seventh learning objective in Chapter 18 is to explain the
basis of corporate dividends, including the similarities and
differences between cash and property dividends.
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to cover the dividend.
In order to declare and pay a cash dividend to shareholders, a
corporation must have
Sufficient retained earnings to absorb the dividend with out going
negative.
Enough cash to pay the dividend.
Dividends are not legally required but rather are declared at the
discretion of the board of directors. When dividends are declared,
a liability is created.
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Record a liability.
There are four important dates to remember when discussing
dividends.
Declaration date.
Ex-dividend date.
Record date.
Payment date
The declaration date is the date the directors declare the
dividend. At this time a liability is created. To record the
dividend declaration, we debit retained earnings and credit the
liability dividends payable.
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Dividend Dates
Ex-dividend date
The first day the shares trade without the right to receive the
declared dividend.
(No entry)
July
X
The ex-dividend date is an important date for purchasers and owners
of stock. This is the date which serves as the ownership cut-off
point for the receipt of the most recent declared dividend. If you
buy stock after this date but before the payment date, you will not
receive the dividend. A journal entry is not required on the
ex-dividend date.
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Date of record
Stockholders holding shares on this date will receive the dividend.
(No entry)
July
X
X
July
The date of record is important to investors because the stock must
be owned on this date to receive the dividend. Although a journal
entry is not required on the record date, the company prepares a
list of registered owners as of this date. The persons on that list
will receive the dividend.
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dividend to stockholders.
On the payment date, the company debits dividends payable to remove
the liability and credits cash for the amount of dividends
paid.
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Record at fair value of non-cash asset.
Recognize gain or loss for difference between book value and fair
value.
Property dividends are distributions of non-cash assets. The
dividend is recorded at the fair value of the non-cash assets
distributed.. A gain or loss for difference between book value and
fair value of the assets distributed is recognized.
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Explain stock dividends and stock splits
and how they are accounted for.
Our eighth learning objective in Chapter 18 is to explain stock
dividends and stock splits and how they are accounted for.
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All shareholders receive the same percentage increase in
shares.
No change in total shareholders’ equity.
A stock dividend is a distribution of additional shares of stock to
stockholders. Stock dividends do not change the assets or
liabilities of the business. All stockholders retain the same
percentage ownership. The stockholders have more shares of stock
representing the same ownership as they had before the stock
dividend. There is no change in total stockholders’ equity.
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Remind stockholders of the accounting wealth in the company,
while
preserving cash..
Reduce the market price per share of stock to make the shares
more
affordable for investors to purchase.
Signal that the management expects strong financial performance in
the
future.
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of stock.
>
A stock dividend can be classified as small or large. A small stock
dividend is a distribution of stock that is less than twenty-five
percent of the outstanding shares. Small stock dividends are
recorded at the market value of the stock.
A large stock dividend is a distribution of stock that is greater
than or equal to twenty-five percent of the outstanding shares.
Large stock dividends are recorded at the par value of the
stock.
Let’s look at the entry to record a small stock dividend.
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Stock Dividends
CarCo declares and distributes a 20% stock dividend on 5 million
common shares. Par value is $1 and market value is $20. Prepare the
required journal entry.
CarCo declares and distributes a 20% stock dividend on 5 million
common shares. Par value is $1 and market value is $20. Prepare the
required journal entry.
Sheet: Sheet1
Sheet: Sheet2
Sheet: Sheet3
Sheet: Sheet4
Sheet: Sheet5
Sheet: Sheet6
Sheet: Sheet7
Sheet: Sheet8
Sheet: Sheet9
Sheet: Sheet10
Sheet: Sheet11
Sheet: Sheet12
Sheet: Sheet13
Sheet: Sheet14
Sheet: Sheet15
Sheet: Sheet16
GENERAL JOURNAL
Page 21
Stock Dividends
CarCo declares and distributes a 20% stock dividend on 5 million
common shares. Par value is $1 and market value is $20. Prepare the
required journal entry.
A small stock dividend requires a reclassification of retained
earnings to paid-in capital equal to the fair value of the
additional shares distributed.
The number of shares distributed is 20 percent of 5,000,000 shares
outstanding or 1,000,000 shares. We multiply 1,000,000 shares times
$20 per share to get the total market value of $20,000,000. Total
par value is 1,000,000 times the $1 par value per share.
The journal entry requires a debit to retained earnings for
$20,000,000, a credit to common stock for $1,000,000 and a credit
to paid-in capital in excess of par for $19,000,000, the difference
between the $20,000,000 market value and the $1,000,000 par value
of the shares distributed.
Sheet: Sheet1
Sheet: Sheet2
Sheet: Sheet3
Sheet: Sheet4
Sheet: Sheet5
Sheet: Sheet6
Sheet: Sheet7
Sheet: Sheet8
Sheet: Sheet9
Sheet: Sheet10
Sheet: Sheet11
Sheet: Sheet12
Sheet: Sheet13
Sheet: Sheet14
Sheet: Sheet15
Sheet: Sheet16
GENERAL JOURNAL
Page 21
No change in total stockholders’ equity.
Does not require a journal entry.
Ice Cream Parlor
Banana Splits On Sale Now
A stock split is the distribution of additional shares of stock to
stockholders according to their percentage ownership. When a stock
split occurs, the corporation calls in the outstanding shares and
issues new shares of stock. In the process of a stock split, the
par value of the stock changes, but retained earnings is unchanged.
Each shareholder has the same percentage ownership of the company
after the split as before the split. A journal entry is not
required to record a stock split.
Let’s look at an example.
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before a 2–for–1 stock split.
Before the two-for-one split, the corporation had 5,000 shares of
its $1 per share par value common ctock outstanding.
Let’s see what happens as a result of the two-for-one split.
Sheet1
before a 2–for–1 stock split.
After the split, the number of shares doubled to 10,000 and the par
value was cut in half to $0.50 per share. There is no change in
total par value of the shares outstanding. Notice that an
accounting entry is not required, and that retained earnings is not
reduced.
In many respects a one hundred percent stock dividend and a
two-for-one stock split result in similar impacts to the price per
share in the stock market. The stock split usually requires more
administrative tasks to call in and reissue stock
certificates.
Sheet1
Stock Splits Effected in the
Form of Large Stock Dividends
Matrix, Inc. declares and distributes a 2-for-1 stock split
effected in the form of a 100% stock dividend. The company has
1,000,000, $1 par value common stock outstanding. The stock is
trading in the open market for $14 per share. The per share par
value of the shares is not to be changed.
Most investors refer to large stock dividends as stock splits. For
example a 100 percent stock dividend may be called a two-for-one
stock split. Even though it is referred to as a stock split, it is
accounted for as a large stock dividend, with par value remaining
unchanged.
Recall that large stock dividends are accounted for at par value.
There are two approaches that a company might take:
Reduce paid-in capital in excess of par to offset the credit to
common
stock for the par value of shares distributed.
Reduce (capitalize) retained earnings to offset the credit to
common
stock for the par value of shares distributed.
Let’s look at the example on your screen for the first
approach.
Matrix, Inc. declares and distributes a 2-for-1 stock split
effected in the form of a 100% stock dividend. The company has
1,000,000, $1 par value common stock outstanding. The stock is
trading in the open market for $14 per share. The per share par
value of the shares is not to be changed.
We debit paid-in capital in excess of par and credit common stock
for the $1,000,000 par value of the shares distributed.
Sheet1
1,000,000
Stock Splits Effected in the
Form of Large Stock Dividends
Matrix, Inc. declares and distributes a 2-for-1 stock split
effected in the form of a 100% stock dividend. The company has
1,000,000, $1 par value common stock outstanding. The stock is
trading in the open market for $14 per share. The per share par
value of the shares is not to be changed and the company will
capitalize retained earnings.
The second approach reduces retained earnings. The information is
the same except for the last statement that says the company will
capitalize retained earnings.
In this case, we debit retained earnings and credit common stock
for the $1,000,000 par value of the shares distributed.
Sheet1
Purpose
To allow a company undergoing financial difficulty, but with
favorable future prospects, to get a fresh start by writing down
inflated assets and eliminating an accumulated balance in retained
earnings.
A quasi reorganization allows a company undergoing financial
difficulty, but with favorable future prospects, to get a fresh
start by writing down inflated assets and eliminating an
accumulated balance in retained earnings.
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Procedures
The firm’s assets and liabilities are revalued to reflect market
values, with corresponding debits and credits to retained
earnings.
The debit balance in retained earnings is eliminated first against
additional paid in capital, and then, if necessary, against common
stock.
Retained earnings is dated to indicate when the new accumulation of
earnings began.
The following steps are followed in a reorganization:
The firm’s assets and liabilities are revalued to reflect market
values, with
corresponding debits and credits to retained earnings.
The debit balance in retained earnings (deficit) is eliminated
first against
additional paid in capital, and then, if necessary, against common
stock.
Retained earnings is dated to indicate when the new accumulation
of
earnings began.
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quasi reorganization, subject
to shareholder approval.
restatement, in millions, follows :
Emerson-Walsch Corporation has incurred losses for several years.
The board
of directors voted to implement a quasi reorganization, subject to
shareholder approval. Let’s examine the balance sheet prior to
restatement.
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necessary for the quasi reorganization.
Fair value of the inventory is $300,000,000 and fair value
of the property, plant, and equipment is $225,000,000.
Notice the deficit in retained earnings. The quasi reorganization
will eliminate this deficit, but first, we must restate the assets
to reflect their fair values. Fair value of the inventory is
$300,000,000 and fair value of the property, plant, and equipment
is $225,000,000. Restating the assets to fair values that are lower
than the balance sheet carrying value will increase the deficit in
retained earnings.
Sheet1
(millions)
Cash
$ 75
Receivables
200
Inventory
375
400
800
To revalue assets.
The inventory fair value of $300,000,000 is $75,000,000 less than
the amount shown on the balance sheet for inventory. The property,
plant, and equipment fair value of $225,000,000 is $175,000,000
less than the amount shown on the balance sheet for property,
plant, and equipment. We credit inventory and property, plant, and
equipment to reduce them to fair value. We debit retained earnings
to absorb the reductions in inventory and property, plant, and
equipment. The $250,000,000 debit to retained earnings increases
the retained earnings deficit from $300,000,000 to
$550,000,000.
Sheet1
immediately after restatement.
$300 + $250
We credit retained earnings to eliminate the deficit (debit
balance) of $550,000,000. The $150,000,000 balance in additional
paid-in-capital is insufficient to absorb the entire deficit in
retained earnings, so the remaining debit is to common stock for
$400,000,000.
Sheet1
Quasi Reorganizations
After the quasi reorganization, assets are stated at fair value and
the deficit in retained earnings has been eliminated.
Sheet1
Cash
$ 75
Receivables
200
Inventory
300
225
400
Net income25,000
Cash dividends(10,000)
Common Stock1,000,000
Total assets1,050$
Additional paid-in capital150
Retained earnings (deficit)(300)
Total assets800$
Additional paid-in capital0
GENERAL JOURNAL
Page 8
Common stock100,000
authorized; 20,000 shares issued and
outstanding200,000$
authorized; 400 shares issued and
outstanding40,000
Total paid-in capital550,000
Stated Value, Common Stock90,000
Paid-in Capital - Share Repurchase15,000
Paid-in Capital - Share Repurchase25,000
Dec. 3, 2006
GENERAL JOURNAL
Page 12
Total Par Value5,000$ 5,000$
Total assets1,050$
Additional paid-in capital150
Retained earnings (deficit)(300)
Total assets800$
Additional paid-in capital0
Shareholders' Equity
Captial Stock:
authorized; 20,000 shares issued and
outstanding200,000$
authorized; 400 shares issued and
outstanding40,000
Total paid-in capital550,000