©2009 pearson prentice hall. all rights reserved. 9-1 stockholders’ equity chapter 9

©2009 Pearson Prentice Hall. All rights reserved.

9-1

Stockholders’ Equity

Chapter 9


9-2

Learning Objective 1

Explain the features of a corporation


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


9-4

Organizing a Corporation

• Incorporators Organize the corporation Pay fees Sign charter File documents with the state Agree to bylaws


9-5

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


9-6

Stockholders’ Rights

• Vote at stockholder meetings

• Receive dividends

• Receive share if corporation liquidates

• Maintain proportionate ownership Preemptive right


9-7

Parts of Stockholders’ Equity

• Paid-in capital Represents amounts contributed by

stockholders Include stock accounts

• Retained earnings Amounts earned and kept by the corporation


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


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


9-10


Account for the issuance of stock


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


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


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?


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


Equipment _________

Common stock _________

Paid-in capital in excess of par $550,000

Fair value of equipment

Shares issued x par value


9-14

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


9-15

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


9-16©2009 Prentice Hall

5-16


Describe how treasury stock affects a company


9-17

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


9-18

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


9-19


• Suppose a company purchased 10,000 shares of its own $1 par common stock for $200,000


Treasury stock $200,000

Cash $200,000


9-20


• Later, the company resells the treasury shares for $250,000


Cash $250,000

Treasury stock _________

Paid-in capital from treasury stock

transactions $50,000

Amount company paid to buy shares


9-21

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


9-22


Account for dividends


9-23

Dividends

• Distribution to stockholders

• Three forms Cash Stock Noncash assets


9-24

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


9-25

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


9-26

Accounting for Dividends

• Date of Declaration

Accounts Debit Credit

Retained Earnings $$$$$

Dividends Payable $$$$$

Equity Decreases; Liabilities Increase


9-27

Accounting for Dividends

• Date of Record – no entry• Date of Payment


Dividends Payable $$$$$

Cash $$$$$

Liabilities Decrease; Assets Decrease


9-28

Retained Earnings

Beginning Balance

Dividends Declared

Ending Balance

Net Income

If retained earnings increases, net income > dividends

If retained earnings decreases, net income < dividends


9-29

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


9-30

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


9-31

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


9-32

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


9-33

Stock Dividends

• Small Less than 25% of outstanding shares Recorded at market value

• Large Greater than 25% of outstanding shares Recorded at par value


9-34

E9-27

• 10% stock dividend – small: recorded at market value 10% x 500,000 shares issued = 50,000 Market value = $17 per share


Retained Earnings __________

Common stock ___________

Paid-in capital in excess of par $845,000

Shares issued x market value

Shares issued x par


9-35

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


9-36

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


9-37

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


9-38


Use stock values in decision making


9-39

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


9-40


Compute return on assets and return on equity


9-41

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


9-42

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


9-43


Report equity transactions on the statement of cash flows


9-44

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


9-45

End of Chapter 9

©2009 pearson prentice hall. all rights reserved. 9-1 stockholders’ equity chapter 9

Documents

pearson prentice hall

par value stock

par value common stock

corporation slide

issuance of stock slide

common stock account

stock accounts

stockholders rights