contributed capital 12. management issues related to contributed capital objective 1: identify and...

Contributed Capital12

Management Issues Related to Contributed Capital

OBJECTIVE 1: Identify and explain the management issues related to contributed capital.

Key Ratios

• Dividends yield

• Return on equity

• Price/earnings (P/E) ratio

Figure 1: The Corporate Organization

Figure 2: Dividend Dates

Management Issues Related to Contributed Capital

• A corporation is a business organization authorized by the state and considered a separate legal entity from its owners.– Articles of incorporation form the company

charter.– Share of stock is unit of ownership.– Board of directors decide major business

policies.

Management Issues Related to Contributed Capital

• A corporation is a business organization authorized by the state and considered a separate legal entity from its owners. (cont.)– Dividends are distributions of resources to

stockholders.– Corporate officers are appointed by the board

of directors.

Management Issues Related to Contributed Capital

• Advantages and disadvantages of corporate form of business– Advantages to the corporate form of business.

• Separate legal entity• Limited liability of owners• Ease of capital generation• Ease of transfer of ownership • Lack of mutual agency• Continuous existence• Centralized authority and responsibility• Professional management

Management Issues Related to Contributed Capital

• Advantages and disadvantages of corporate form of business(cont.)– Disadvantages to the corporate form of

business.• Government regulation

• Double taxation

• Limited liability of owners

• Separation of ownership and control

Management Issues Related to Contributed Capital

• Equity Financing– Par value is an arbitrary amount assigned to

each share of stock; legal capital equals the number of shares issued times the par value.

– In IPOs, stock is generally issued through an underwriter.

Management Issues Related to Contributed Capital

• Equity Financing(cont.)– Start-up and organization costs consist of all

costs of forming a corporation.– Start-up and organization costs usually are

expensed when incurred.

Management Issues Related to Contributed Capital

• Dividend policies– Stockholders can earn a return on their

investment in one of two ways.• Through dividends paid by the corporation

• By selling their shares of stock for more than they paid for them

Management Issues Related to Contributed Capital

• Dividend policies (cont.)– The board of directors has sole authority to

declare dividends.• Dividend policies are usually influenced by top

management.

• Dividends are usually paid when a company has experienced profitable operations; however, two other considerations will affect the decision to make dividend payments.

– The expected volatility of earnings

– The level of cash flows

Management Issues Related to Contributed Capital

• Dividend policies (cont.)– The board of directors has sole authority to

declare dividends. (cont.)• Dividends can be paid quarterly, semiannually,

annually, or as decided by the board of directors.

• A liquidating dividend is the return of contributed capital to the stockholders and is normally paid when a company is going out of business or reducing operations.

Management Issues Related to Contributed Capital

• Dividend policies (cont.)– There are three dates associated with a cash

dividend.• Declaration date

• Record date

• Date of payment

Management Issues Related to Contributed Capital

• Dividend policies (cont.)– Stock sold after the date of record is sold ex-

dividend.

Management Issues Related to Contributed Capital

• Dividend policies (cont.)– Common ratios

• Dividends yield

• Return on equity

• Price/earnings ratio

Management Issues Related to Contributed Capital

• The return on equity ratio is the most important ratio associated with stockholders’ equity.– The return on equity ratio is affected by the

following:• The amount of net income the company earns

• The company’s level of average stockholders’ equity

Management Issues Related to Contributed Capital

• The return on equity ratio is the most important ratio associated with stockholders’ equity. (cont.)– Stockholders’ equity is affected by

management decisions.• How much stock a company sells to the public

• How many shares the company buys back on the open market (reducing the number of shares held by the public), known as treasury stock

Management Issues Related to Contributed Capital

• A stock option plan gives corporate employees the right to purchase stock in a certain quantity and at a certain price.– Most plans are intended to compensate

employees (usually management).– The amount of compensation equals the market

price on the date the option is granted minus the option price.

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Components of Stockholders’ Equity

OBJECTIVE 2: Identify the components of stockholders’ equity.

Exhibit 1: Stockholders’ Equity Section of a Balance Sheet

Figure 3: Relationship of Authorized Shares to Unissued, Issued, Outstanding, and Treasury Shares

Components of Stockholders’ Equity

• Stockholders’ equity is composed of contributed capital and retained earnings.

• When only one type of stock is issued, it is called common stock.

• The second kind of stock a company can issue is preferred stock.

Components of Stockholders’ Equity

• Authorized shares are the maximum number of shares the corporation is allowed to issue according to its state charter.

• Issued shares represent the number of shares sold or otherwise transferred to stockholders.

• Outstanding shares are shares that have been issued and are still held by stockholders.

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Preferred Stock

OBJECTIVE 3: Identify the characteristics of preferred stock.

Preferred Stock

• Holders of preferred stock are given preference over common shareholders when dividends (and liquidating dividends) are declared; that is, the holders of preferred shares must receive a certain amount of dividends before the holders of common shares can receive dividends. – This dividend is a specific dollar amount or

percentage of par value.

Preferred Stock

• Holders of preferred stock... (cont.) – Preferred stockholders receive their dividends

before common stockholders receive anything. – Once preferred stockholders have received the

annual dividends to which they are entitled, however, common stockholders generally receive the remainder.

Preferred Stock

• Dividends in arrears are unpaid “back dividends” on cumulative preferred stock.

• When a dividend is declared by the board of directors, Cash Dividends Declared is debited and Cash Dividends Payable is credited.

Preferred Stock

• Convertible preferred stock can be exchanged for common stock at a predetermined ratio.

• Callable preferred stock can be redeemed or retired at the option of the issuing corporation.

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Issuance of Common Stock

OBJECTIVE 4: Account for the issuance of stock for cash and other assets.

Issuance of Common Stock

• Common and preferred stock may or may not have a par value.– Par value is the legal value established for a

share of stock.

Issuance of Common Stock

• No-par stock may be issued with or without a stated value.– The total stated value is recorded in the Capital

Stock account. Any amount received in excess of the stated value is recorded as Additional Paid-in Capital.

– If no stated value is set, however, the entire amount received constitutes legal capital and is credited to Capital Stock.

Issuance of Common Stock

Issuance of Common Stock

• When stock is issued in exchange for assets or for services rendered, the stock should be recorded at the fair market value of the assets or services, unless the fair market value of the stock is more easily determined.

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Accounting for Treasury Stock

OBJECTIVE 5: Account for treasury stock.

Accounting for Treasury Stock

• Treasury stock is issued stock that the issuing corporation has reacquired for any of the following reasons:– To use for stock option plans– To maintain a favorable market for the

company’s stock– To increase earnings per share

Accounting for Treasury Stock

• Treasury stock is issued stock that the issuing corporation has reacquired for any of the following reasons: (cont.)– To use to purchase other companies– To prevent a hostile takeover of the company

Accounting for Treasury Stock

• Treasury stock is the last item (a deduction) in the stockholders’ equity section of the balance sheet.– Treasury stock appears on the balance sheet as

the last item in the stockholders’ equity section, as a deduction.

Accounting for Treasury Stock

• Treasury stock is the last item (a deduction) in the stockholders’ equity section of the balance sheet. (cont.)– Reissuance of treasury stock (at cost, above cost,

and below cost).• When cash received from reissuance exceeds the cost,

the difference is credited to Paid-in Capital, Treasury Stock.

• When cash received from reissuance is less than the cost, Paid-in Capital, Treasury Stock (and Retained Earnings, if needed) is debited for the difference.

• In no instance should a gain or loss account be established.

Accounting for Treasury Stock

• Treasury stock is the last item (a deduction) in the stockholders’ equity section of the balance sheet. (cont.)– Gains and losses are not recognized on treasury

stock transactions.

Accounting for Treasury Stock

• When stock is retired, all the contributed capital associated with it must be removed from the accounts.– When less was paid on reacquisition than was

contributed originally, the difference is credited to Paid-in Capital, Retirement of Stock.

– When more is paid, the difference is debited to Retained Earnings.

Accounting for Treasury Stock

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