1 © copyright doug hillman 1999 additional stockholders’ equity transactions and income...

1© Copyright Doug Hillman 1999

Additional Stockholders’

Equity Transactions and Income Disclosures


Retained Earnings Cumulative net income of past years minus

net losses and dividends declared during those years

Primary factors affecting retained earnings› Net income or loss› Restrictions of retained earnings› Prior period adjustments› Dividends


Restrictions on Retained Earnings

Tells the financial statement reader that company may not pay out this part of retained earnings as dividends

Required restrictions› To comply with legal or contractual limits on

dividend distribution Voluntary

› To show reasons why management wishes to restrict dividends


Prior Period Adjustment An error in preparing financial statements in

one accounting period not discovered until a later period

Treat correction of error, if material, as adjustment of beginning retained earnings› Adjusts affected balance sheet account› Adjusts beginning retained earnings


Dividends

Distribution of cash, stock, or other corporate assets to stockholders

Declaration decreases retained earnings When board of directors takes formal

action, declaration, dividend immediately becomes liability


Cash Dividend Date of declaration

› Increase Dividends - a nominal account closed to Retained Earnings

› Increase Dividends Payable Date of record

› No entry

› Determines persons who will receive dividend

› Stock sold after is sold ex-dividend


Cash Dividend

Date of payment

› Decreases Cash

› Decreases Dividends Payable Cumulative preferred in arrears

› First must pay arrearages

› Then pay current period preferred

› Then common is entitled to dividends


Stock Dividends

Issuance of additional shares of authorized stock

Reasons

› Need to conserve cash

› Give measure of company’s success

› Increase permanent capitalization

› Decrease market price


Small Stock Dividend

Involves less than 20-25% of previously outstanding shares

Transfer from retained earnings to paid-in capital an amount equal to market value of shares

Reasoning is that small stock dividends do not decrease market value significantly



Date of declaration› Increase Stock Dividends , a nominal

account closed to Retained Earnings, for market value

› Increase Stock Dividends to be Issued for par value

› Increase Paid-in Capital-Excess Over Par for difference



Stock Dividends to be Issued appears in paid-in capital

Date of payment

› Decrease Stock Dividends to be Issued

› Increase Stock


Large Stock Dividend

Involves more than 20-25% of previously outstanding shares

Transfer from retained earnings to paid-in capital an amount equal to par value of shares

Reasoning is that large stock dividend should decrease market value



Date of declaration› Increase Stock Dividends , a nominal

account closed to Retained Earnings, for par value

› Increase Stock Dividends to be Issued for par value

Stock Dividends to be Issued appears in paid-in capital



Date of payment

› Decrease Stock Dividends to be Issued

› Increase Stock


Effect of Stock Dividend

Small stock dividend

› Increase paid-in capital by market value of shares issued in dividend

› Decreases retained earnings by market value of shares issued in dividend


Effect of Stock Dividend

Large stock dividend

› Increases paid-in capital by par value of shares issued in dividend

› Decreases retained earnings by par value of shares issued in dividend

Capitalizes (makes permanent) some of retained earnings


Stock Split

Decreases the par or stated value per share and increases number of shares issued proportionally

Total paid-in capital remains the same Total retained earnings remains the

same Market value of shares decreases

proportionally


Treasury Stock

Shares of own stock reacquired by corporation

Acquisition reduces assets and stockholders’ equity

Shown as deduction from stockholders’ equity


Treasury Stock

Acquisition

› Increases contra owners’ equity account Treasury Stock by cost

› Decreases Cash


Treasury Stock

Reissuance above cost

› Increases cash by proceeds

› Decreases Treasury Stock by cost

› Increases Paid-in Capital from Treasury Stock Transactions by difference


Treasury Stock

Reissuance below cost

› Increases cash by proceeds

› Decreases Treasury Stock by cost

› Decreases Paid-in Capital from Treasury Stock Transactions by difference


Treasury Stock

Reissuance below cost

› If Paid-in Capital from Treasury Stock Transactions does not exist

–decrease any paid-in capital from same class of stock

–retained earnings


Book Value of Common Stock

Divide stockholders’ equity available to common stockholders by number of shares outstanding

When more than one class of stock is outstanding› subtract liquidation claims of noncommon

from total stockholders’ equity to determine equity available to common


Presentation of Stockholders’ Equity

Paid-in capital

Stock

Common stock, $1 par,

10,000 sh authorized,

8,000 sh issued $ 8,000

Additional paid-in capital

Paid-in capital-excess over

par, common 24,000

Total paid-in capital $32,000


Presentation of Stockholders’ Equity

Retained earnings

Restricted for plant

expansion $10,000

Unrestricted 50,000

Total retained earnings 60,000

Total paid-in capital and R.E. $92,000

Deduct: Treasury stock 1,000

Total stockholders’ equity $91,000


Quality of Income Information

Accounting methods and estimates used to prepare financial statements

Number and size of nonrecurring revenue and expense items on income statement


Intraperiod Tax Allocation

Assigning the tax consequences of nonrecurring items to the item

Assume a nonrecurring loss of $40,000 with a tax rate of 30%

Loss $40,000

Tax savings due to loss 12,000

Loss net of tax $28,000


Continuing Operations

Financial statement users want to know income from continuing operations

It is important number for predicting future earnings


Nonrecurring Income Statement Items

Discontinued operations Extraordinary items Cumulative effect of change in

accounting principle


Discontinued Operations

A line of business or class of customer may qualify as discontinued segment

When management decides to dispose of a segment, results for segment must be reported separately


Discontinued Operations

Two elements reported for discontinued segment

› Operating income or loss for period

› Gain or loss on disposal of the segment

Each element reported net of tax


Extraordinary Items

Gains and losses that are both unusual and infrequent

Must consider the environment in which firm operates

Reported net of tax


Examples of Extraordinary Items

Uninsured losses from earthquakes and fires

Gains or losses from early retirement of debt

Gains and losses from passing a new law Gains and losses from foreign

governments taking business property


Changes in Accounting Principle

Consistency principle states should use same accounting principles from period to period

Change permitted when it improves reporting

Reported net of tax


Changes in Accounting Principle

Changes in principle often would have changed prior periods’ expenses

Total change in net income for prior periods is cumulative effect of a change in accounting principle


Reporting Earnings Per Share

Income from continuing operations Discontinued operations Extraordinary items Cumulative effect of change in

accounting principle Net income


Earnings Per Share Expresses net income on a per-common-

share basis Under FASB Statement No. 128 presentation

depends on whether simple or complex capital structure

Simple capital structure - no debt or equity that could dilute EPS

Complex capital structure - dilutive securities


EPS - Weighted Average Common Shares

For total year, sum of

› Number of shares outstanding times fraction of year outstanding

Used as denominator in EPS calculations


EPS - Simple Capital Structure

Net income minus dividends on preferred stock

divided by Weighted average number of common

shares outstanding


Complex Capital Structure Convertible debt or equity securities that

have potential to dilute (decrease) EPS Present two earnings per share figures Basic earnings per share

› EPS based on weighted average common shares

Diluted earnings per share› Assumes all dilutive securities converted


EPS Example Net income $48,000 Stock

› 10% Convertible Preferred, $100 par, 1,000 shares issued and outstanding, convertible into 7,000 common

› Common, $1 par, – Issued and outstanding 1/1 to 4/1, 16,000 shares– Issued and outstanding 4/1 to 12/31, 20,000

shares


EPS Example

Weighted average common shares outstanding computation

› 16,000 x 1/4 = 4,000

› 20,000 x 3/4 = 15,000 Weighted average common shares

outstanding

› 19,000 shares


Basic EPS Computation

Preferred dividends

› 1,000 x ($100 x 0.10) = $10,000 Net income available to common

› $48,000 - $10,000 = $38,000 Basic EPS

› $38,000 / 19,000 = $2.00 per share


Diluted Earnings Per Share Assume convertible preferred converted into

common at beginning of year Weighted average common shares

› 19,000 + 7,000 = 26,000 Net income available to common

› $48,000 - $0 = $48,000 Diluted EPS

› $48,000 / 26,000 = $1.85 per share


Analyzing Information Major differences in capital structure between

companies Number of shares issued and outstanding Treasury stock Market value Dividend yield ROA EPS and P/E ratio

1 © copyright doug hillman 1999 additional stockholders’ equity transactions and income...

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