chapter 10 stockholders equity mcgraw-hill/irwin copyright © 2011 by the mcgraw-hill companies,...

Chapter 10

Stockholders’ Equity

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Stockholders’ Equity

Stockholders’ Equity = Assets - LiabilitiesStockholders’ Equity = Assets - Liabilities

Primary Sections of Stockholders’ Equity

Paid-in capital Retained Earnings Treasury Stock

Amount stockholders have

invested in the corporation

Amount of earnings the corporation has

retained

Corporation’s own stock that it has

reacquired

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Part A

Invested Capital

10-3

LO1 Corporations

o Articles of incorporation (or corporate charter) describe

a) the nature of the firm’s business activities

b) the shares to be issued

c) the initial board of directors

o Corporation’s stockholders control the corporation - By voting their shares, they determine the makeup of the board of directors - which in turn appoints the management to run the corporation.

o Articles of incorporation (or corporate charter) describe

a) the nature of the firm’s business activities

b) the shares to be issued

c) the initial board of directors

o Corporation’s stockholders control the corporation - By voting their shares, they determine the makeup of the board of directors - which in turn appoints the management to run the corporation.

10-4

Public or Private

Stocks trade on a stock exchanges such as NYSE, AMEX, NASDAQ; or by over-the-counter (OTC) trading.

Regulated by the Securities and Exchange Commission (SEC)

Examples – Wal-Mart, Microsoft, Intel

Does not allow investment by the general public and has fewer stockholders

Not regulated by the Securities and Exchange Commission (SEC) and do not need to file financial statements with it

Examples - Cargill (agricultural commodities) Koch Industries (oil and gas), Chrysler (cars)

Corporations may be either public or private

Public Private

10-5

Advantages and Disadvantages of a Corporation

Additional taxes

More paperwork

Limited liability

Ability to raise capital

Lack of mutual agency

Advantages Disadvantages

10-6

LO2 Common Stock

Type of Stock Definition Authorized Shares available to sell

(issued and unissued) Issued Shares actually sold

(includes treasury stock) Outstanding Shares held by investors

(excludes treasury stock)Authorized – Unissued = Issued

Issued – Treasury Stock = Outstanding

o If a corporation has only one kind of stock, it usually is labeled as common stock.

o If a corporation has only one kind of stock, it usually is labeled as common stock.

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LO3 Preferred Stock

Usually have first rights to a specified amount of Dividends. Receive preference over common stockholders in the

distribution of assets in the event the corporation is dissolved.

Usually have first rights to a specified amount of Dividends. Receive preference over common stockholders in the

distribution of assets in the event the corporation is dissolved.

FactorCommon

StockPreferred

Stock Bonds

Voting rights Yes Usually No No

Risk to the investor Highest Middle Lowest

Expected return to the investor

Highest Middle Lowest

Risk of contract violations Lowest Middle Highest

Preference for payments Lowest Middle Highest

Tax deductibility of payments No Usually No Yes

Comparison of common stock, preferred stock, and bonds

10-8

Features of Preferred Stock

Flexibility allowed in its contractual provisions

Convertible Redeemable Cumulative

Shares can be exchanged for common stock

Shares can be returned to the corporation at a

fixed price

Shares receive priority for future

dividends, if dividends are not

paid in a given year

10-9

LO4 Treasury Stock

Why corporations repurchase their stock To boost under-priced stock. To distribute surplus cash without paying

dividends. To boost earnings per share. To offset issuance of shares under stock-

based compensation plans.

Why corporations repurchase their stock To boost under-priced stock. To distribute surplus cash without paying

dividends. To boost earnings per share. To offset issuance of shares under stock-

based compensation plans.

A corporation’s own stock that it has reacquired

10-10

Part B

Earned Capital

10-11

LO5 Retained Earnings and Dividends

RETAINED EARNINGS

o Represents the earnings retained in the corporation – earnings not paid out as dividends to stockholders.

o Equals all net income, less all dividends, since the corporation began.

o Has a normal credit balance consistent with other stockholders’ equity accounts.

o If losses exceed income since the corporation began, retained earnings will have a debit balance and is called an accumulated deficit.

o Represents the earnings retained in the corporation – earnings not paid out as dividends to stockholders.

o Equals all net income, less all dividends, since the corporation began.

o Has a normal credit balance consistent with other stockholders’ equity accounts.

o If losses exceed income since the corporation began, retained earnings will have a debit balance and is called an accumulated deficit.

10-12

LO6 Stock Dividends and Stock Splits

Sometimes, corporations distribute to shareholders additional shares of the companies’ own stock rather than cash. These are known as stock dividends or stock splits depending on

the size of the stock distribution.

You own 100 shares and assume a

You will get

10% stock dividend 10 additional shares

20% stock dividend 20 additional shares

100% stock dividend 100 additional shares

Small stock dividend

Large stock dividend or stock split (2-for-1)

10-13

Part C

Reporting and Analyzing Stockholders’ Equity

10-14

LO8 Equity Analysis

Equity Analysis

Return on Equity

Return on the Market Value of Equity

Price-Earnings Ratio

Earnings Per Share

10-15

End of chapter 10

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