© the mcgraw-hill companies, inc., 2008 mcgraw-hill/irwin stockholders’ equity: paid-in capital...
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© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
STOCKHOLDERS’ EQUITY:Paid-In Capital
Chapter
11
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Existence is separate from
owners.
Existence is separate from
owners.
An entity created by law.
An entity created by law.
Has rights and privileges.
Has rights and privileges.
Privately, or Closely, Held
Publicly Held
Ownership can be
CorporationsCorporations
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Learning ObjectiveLearning Objective
LO1
To discuss the advantages and disadvantages of
organizing a business as a corporation.
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Limited personal liability for
stockholders
Limited personal liability for
stockholders
Transferability of ownership
Transferability of ownership
Professional management
Professional management
Continuity of existence
Continuity of existence
Advantages of IncorporationAdvantages of Incorporation
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Heavy taxationHeavy taxation
Greater regulationGreater regulation
Cost of formationCost of formation
Separation of ownership and management
Separation of ownership and management
Disadvantages of IncorporationDisadvantages of Incorporation
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Learning ObjectiveLearning Objective
LO2
To distinguish between publicly owned and
closely held corporations.
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Publicly Owned Corporations Face Different Rules
Publicly Owned Corporations Face Different Rules
By LAW, publicly owned corporations must:By LAW, publicly owned corporations must: Prepare financial statements in accordance Prepare financial statements in accordance
with GAAP.with GAAP. Have their financial statement audited by an Have their financial statement audited by an
independent CPA.independent CPA. Comply with federal securities laws.Comply with federal securities laws. Submit financial information for SEC review.Submit financial information for SEC review.
By LAW, publicly owned corporations must:By LAW, publicly owned corporations must: Prepare financial statements in accordance Prepare financial statements in accordance
with GAAP.with GAAP. Have their financial statement audited by an Have their financial statement audited by an
independent CPA.independent CPA. Comply with federal securities laws.Comply with federal securities laws. Submit financial information for SEC review.Submit financial information for SEC review.
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The costs associated with incorporation are usually
expensed immediately, but amortized over 5 years for
tax purposes.
The costs associated with incorporation are usually
expensed immediately, but amortized over 5 years for
tax purposes.
Formation of a CorporationFormation of a Corporation
• Each corporation is formed according to the laws of the state where it is located.
• The application for corporate status is called the Articles of Incorporation.
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Learning ObjectiveLearning Objective
LO3
To explain the rights of stockholders and the
roles of corporate directors and officers.
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Stockholders
Rights
Voting (in person or by proxy).
Proportionate distribution of
dividends.
Proportionate distribution of
assets in a liquidation.
Rights of StockholdersRights of Stockholders
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C orpora te O rgan iza tion C hart
Secretary Treasurer C ontro ller O ther V icePresidents
President
B oard of D irectors
StockholdersUltimate control
Ultimate control
Stockholders usually meet once a year.
Stockholders usually meet once a year.
Rights of StockholdersRights of Stockholders
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C orpora te O rgan iza tion C hart
Secretary Treasurer C ontro ller O ther V icePresidents
President
B oard of D irectors
StockholdersUltimate control
Ultimate control
Stockholders usually meet once a year.
Stockholders usually meet once a year.
Stockholder ledgers are often maintained by a stock transfer agent or stock
registrar.
Stockholder ledgers are often maintained by a stock transfer agent or stock
registrar.
Rights of StockholdersRights of Stockholders
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Each unit of ownership is
called a share of stock.
Stock certificates serve as proof
that a stockholder has
purchased shares.
Each unit of ownership is
called a share of stock.
Stock certificates serve as proof
that a stockholder has
purchased shares.
Rights of StockholdersRights of Stockholders
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When the stock is sold, the stockholder
signs a transfer endorsement on the back of the
stock certificate.
Rights of StockholdersRights of Stockholders
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C orpora te O rgan iza tion C hart
Secretary Treasurer C ontro ller O ther V icePresidents
President
B oard of D irectors
StockholdersOverall
responsibility for managing the company.
Overall responsibility for managing the company.
Selected by a vote of the
stockholders
Selected by a vote of the
stockholders
Functions of the Board of DirectorsFunctions of the Board of Directors
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C orpora te O rgan iza tion C hart
Secretary Treasurer C ontro ller O ther V icePresidents
President
B oard of D irectors
Stockholders
Chief Accountant
Chief Accountant
Contractual and legal representation
Contractual and legal representation
Custodian of funds
Custodian of funds
Functions of the Corporate OfficersFunctions of the Corporate Officers
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Learning ObjectiveLearning Objective
LO4
To account for paid-in capital and prepare the
equity section of a corporate balance
sheet.
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Paid-in Capital
Contributions byinvestors in exchange
for capital stock.
Retained Earnings
Retention of profitsearned by thecorporation.
Stockholders' equity isincreased in tw o ways.
Stockholders’ Equity of a Corporation
Stockholders’ Equity of a Corporation
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The maximum number of
shares of capital stock that can be
sold to the public.
AuthorizedShares
AuthorizedShares
Authorization and Issuanceof Capital Stock
Authorization and Issuanceof Capital Stock
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Issued shares are authorized shares of stock that have been
sold.
Unissued shares are authorized shares of stock that
never have been sold.
Usually shares are
sold through an
underwriter.
Usually shares are
sold through an
underwriter.
AuthorizedShares
AuthorizedShares
Authorization and Issuanceof Capital Stock
Authorization and Issuanceof Capital Stock
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UnissuedUnissuedSharesShares
TreasuryShares
OutstandingShares
Treasury shares are issued shares that
have been reacquired by the corporation.
IssuedShares
IssuedShares
Outstanding shares are issued shares that are
owned by stockholders.
AuthorizedShares
AuthorizedShares
Authorization and Issuanceof Capital Stock
Authorization and Issuanceof Capital Stock
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Par value is an arbitrary amount
assigned to each share of
stock when it is authorized.
Market price is the amount that each share of stock will sell
for in the market.
Market price is the amount that each share of stock will sell
for in the market.
Stockholders’ EquityStockholders’ Equity
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Common stock can be issued in three forms:Common stock can be issued in three forms:
No-Par Common
Stock
No-Par Common
Stock
Par Value Common
Stock
Par Value Common
Stock
Stated Value Common
Stock
Stated Value Common
Stock
All proceeds credited to
Common Stock
All proceeds credited to
Common Stock
Treated like par value
common stock
Treated like par value
common stock
Stockholders’ EquityStockholders’ Equity
Let’s examine this form of
stock.
Let’s examine this form of
stock.
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Matrix, Inc. issues 10,000 shares of its $2 par value stock for $25 per share on
September 1, 2007.
Matrix, Inc. issues 10,000 shares of its $2 par value stock for $25 per share on
September 1, 2007.
Record:
The cash received.
The number of shares issued × the par value per share in the Common Stock account.
The remainder is assigned to Contributed Capital in Excess of Par.
Record:
The cash received.
The number of shares issued × the par value per share in the Common Stock account.
The remainder is assigned to Contributed Capital in Excess of Par.
Issuance of Par Value StockIssuance of Par Value Stock
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Issuance of Par Value StockIssuance of Par Value Stock
Matrix, Inc. issues 10,000 shares of its $2 par value stock for $25 per share on
September 1, 2007.
Matrix, Inc. issues 10,000 shares of its $2 par value stock for $25 per share on
September 1, 2007.
10,000 × $2 = $20,00010,000 × $2 = $20,000
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Issuance of Par Value StockIssuance of Par Value Stock
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Learning ObjectiveLearning Objective
LO5
To contrast the features of common stock with
those of preferred stock.
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A separate class of stock, typically having priority over common shares in . . .
Dividend distributions (rate is usually stated).
Distribution of assets in case of liquidation.
A separate class of stock, typically having priority over common shares in . . .
Dividend distributions (rate is usually stated).
Distribution of assets in case of liquidation.
Cumulative dividend rights.
Cumulative dividend rights.
Normally has no voting
rights.
Normally has no voting
rights.
Usually callable by
the company.
Usually callable by
the company.
Other Features Include:
Preferred StockPreferred Stock
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Vs. NoncumulativeCumulative
Dividends in arrears must be
paid before dividends may be paid on common
stock.
Dividends in arrears must be
paid before dividends may be paid on common
stock.
Undeclared dividends from
current and prior years do not have to be paid in future
years.
Undeclared dividends from
current and prior years do not have to be paid in future
years.
Cumulative Preferred StockCumulative Preferred Stock
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Example: Consider the following partial Statement of Stockholders’ Equity.
During 2007, the directors declare cash dividends of $5,000. In 2008, the directors declare cash
dividends of $42,000.
Stock Preferred as to DividendsStock Preferred as to Dividends
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Stock Preferred as to DividendsStock Preferred as to Dividends
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I just converted 100 shares of preferred stock
into 1,000 shares of common stock and ended up with a higher dividend
yield!
I just converted 100 shares of preferred stock
into 1,000 shares of common stock and ended up with a higher dividend
yield!
Gee, I can’t do that with MYMY preferred
stock!
Gee, I can’t do that with MYMY preferred
stock!
Some preferred stock is convertible
into shares of common stock.
Other Features of Preferred StockOther Features of Preferred Stock
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Preferred StockPreferred Stock
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Learning ObjectiveLearning Objective
LO6
To discuss the factors affecting the market
price of preferred stock and common stock.
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Accounting by the issuer.
Accounting by the issuer.
Accounting by the investor.
Accounting by the investor.
Common stock is carried at original issue
price.
Common stock is carried at original issue
price.
Investments in marketable securities are carried at market
value.
Investments in marketable securities are carried at market
value.
Market ValueMarket Value
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Factors affecting market price of preferred stock:Factors affecting market price of preferred stock:
• Dividend rateDividend rate• RiskRisk• Level of interest ratesLevel of interest rates
Factors affecting market price of preferred stock:Factors affecting market price of preferred stock:
• Dividend rateDividend rate• RiskRisk• Level of interest ratesLevel of interest rates
The return based on the market value is called the
“dividend yield.”
The return based on the market value is called the
“dividend yield.”
Market Price of Preferred StockMarket Price of Preferred Stock
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Factors affecting market price of common stock:
Investors’ expectations of future profitability.
Risk that this level of profitability will not be achieved.
Factors affecting market price of common stock:
Investors’ expectations of future profitability.
Risk that this level of profitability will not be achieved.
Changes in market value have no impact on the
books of the issuer.
Changes in market value have no impact on the
books of the issuer.
Market Price of Common StockMarket Price of Common Stock
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Learning ObjectiveLearning Objective
LO7
To explain the significance of par
value, book value, and market value of capital
stock.
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Book Value per Shareof Common Stock
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=
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Learning ObjectiveLearning Objective
LO8
To explain the purpose and effects of a stock
split.
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Ice Cream Parlor
Banana Splits On Sale Now
Stock SplitsStock Splits
Companies use stock splits to reduce market price.
Outstanding shares increase, but par value is decreased proportionately.
Companies use stock splits to reduce market price.
Outstanding shares increase, but par value is decreased proportionately.
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Assume a corporation has 5,000 shares of $1 par value common stock outstanding
before a 2–for–1 stock split.
Increase
Decrease
No Change
Stock SplitStock Split
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Learning ObjectiveLearning Objective
LO9
To account for treasury stock transactions.
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No voting No voting or or
dividend dividend rightsrights
Contra equity
account
When stock is reacquired, the corporation records the treasury stock at cost.
When stock is reacquired, the corporation records the treasury stock at cost.
Treasury shares are
issued shares that have been reacquired
by the corporation.
Treasury shares are
issued shares that have been reacquired
by the corporation.
Treasury StockTreasury Stock
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On May 1, 2007, East, Inc. reacquires 3,000 shares of its common stock at $55 per share.
Prepare the journal entry for May 1.
Treasury Stock - ExampleTreasury Stock - Example
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On December 3, 2007, East Corp. reissued 1,000 shares of the stock at $75 per share.
Prepare the journal entry for December 3.
Treasury Stock - ExampleTreasury Stock - Example
1,000 shares × $55 cost = $55,0001,000 shares × $55 cost = $55,000
1,000 shares × $75 = $75,0001,000 shares × $75 = $75,000
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Stockholders’ Equity - PresentationStockholders’ Equity - Presentation
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End of Chapter 11End of Chapter 11