chapter 11 · management management compensation package includes salary and stock options. stock...

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Chapter 11

Reporting and Interpreting Owners’ Equity


Business Background

Advantages of a corporation

Simple to become an

owner

Easy to transfer

ownership

Provides limited liability


Business Background

Because a corporation is a separate legal entity, it can . . .

Own assets.

Sue and be sued.

Incur liabilities.

Enter into contracts.


Ownership of a Corporation

Rights

!Voting (in person or by proxy).

"Proportionate distributions of

profits.#Proportionate distributions of

assets in a liquidation.

Stockholders


Ownership of a Corporation

Vice President(Production)

Vice President(Marketing)

Vice President(Finance)

Vice President(Controller)

President

Board of DirectorsInternal (managers) andExternal (non-managers)

Stockholders(Owners of voting shares)

Elected byshareholders

Appointedby directors


Authorized, Issued, and Outstanding Capital Stock

The maximum number of shares of capital

stock that can be sold to the public.

AuthorizedShares



AuthorizedShares Issued

shares are authorized shares of stock that have been

sold.

Unissuedshares are authorized shares of stock that never have been sold.



AuthorizedShares

UnissuedShares

TreasuryShares

OutstandingSharesIssued

SharesTreasury shares are

issued shares that have been reacquired by the

corporation.

Outstanding shares are issued shares that are

owned by stockholders.


Types of Capital Stock

Common Stock

Preferred Stock


Common Stock

Basic voting stock

Ranks after preferred

stock

Dividend set by board of

directors


Par Value and No-par Value Stock

Legal capital is the amount of capital, required by the state, that must remain

invested in the business.

Par Value

Nominal value

Legal capital


Par Value and No-par Value Stock

Par Value

Market Value≠≠≠≠

I get it!


No-par Value Stock

Some states do not require that a

par value be stated in the

charter.

Some states do not

require a par value to be

stated in the charter.


Preferred StockPreference

over common stock

Usually hasno voting

rights

Usually has a fixed dividend

rate


Special Features of Preferred Stock

Convertible preferred stock may be exchanged for common stock.

Convertible preferred stock may be exchanged for common stock.

Callable preferred stock may be repurchased by the corporation at a

predetermined price.

Callable preferred stock may be repurchased by the corporation at a

predetermined price.


Accounting for Capital Stock

Two primary sources of stockholders’ equity

Retained earnings

Contributed capital

Parvalue

Additional paid-in capital


Sale and Issuance of Capital Stock

Initial public offering (IPO)

Seasoned new issue

The first time a corporation sells

stock to the public.

Subsequent sales of new stock to the

public.

Wal-Martissues new

stock.

Wal-Mart


Secondary Markets

Transactions between two investors that do not affect the corporation’s

accounting records. I’d like to sell some of my

Wal-Mart stock.

I’d like to buy some of your

Wal-Mart stock.


GENERAL JOURNAL Page 34Date Description Debit Credit

July 6


On July 6, Wal-Mart issued 100,000 shares of $0.10 par value common

stock for $22 per share.

Prepare the journal entry to record this transaction.



July 6 Cash 2,200,000Common Stock 10,000Capital In Excess of Par Value 2,190,000


100,000 shares × $22 per share = $2,200,000

100,000 shares × $0.10 par value = $10,000

On July 6, Wal-Mart issued 100,000 shares of $0.10 par value common

stock for $22 per share.


Capital Stock Sold for NoncashAssets and/or Services

Record assets or services received at themarket value of the stock at the date of the

transaction.

Record assets or services received at themarket value of the stock at the date of the

transaction.

Accountant

Provides accounting

services

Issues stock Wal-Mart



If the market value of the stock cannot be determined, then the market value of the assets

or services received should be used.

If the market value of the stock cannot be determined, then the market value of the assets

or services received should be used.

Accountant

Provides accounting

services

Issues stock Wal-Mart



Mar. 14


On March 14, Wal-Mart issued 10,000 shares of its $0.10 par value common stock to the Rose Law firms. The stock was selling for

$15 per share.

Prepare the journal entry to record this transaction.



Mar. 14 Legal Fees 150,000Common Stock 1,000Capital In Excess of Par Value 149,000


10,000 shares × $15 per share = $150,000

10,000 shares × $0.10 par value = $1,000

On March 14, Wal-Mart issued 10,000 shares of its $0.10 par value common stock to the Rose Law firms. The stock was selling for

$15 per share.


Stock Options

Management

Management compensation

package includes salary and stock

options.

Stock options allow management to purchase

stock from the corporation at a fraction of the stock’s

value in the secondary market.

If Wal-Mart does not have new stock to issue when the stock options are exercised, then . .

Wal-Mart


Treasury StockWal-Mart buys

its own stock in the secondary

market.(Treasury stock) Stockholders

Management

Management compensation

package includes salary and stock

options.

Stock options allow management to purchase

stock from the corporation at a fraction of the stock’s

value in the secondary market.

Wal-Mart


Treasury Stock

No voting or

dividend rights

Contra equity

account

When stock is reacquired, the corporation records the treasury stock at cost.


Treasury Stock


May 1 Treasury Stock 2,200,000Cash 2,200,000

100,000 shares × $22 = $2,200,000

On May 1, Wal-Mart reacquired 100,000 shares of its common stock at $22 per share.

The journal entry for May 1 is . . . .



Dec. 3 Cash 300,000Treasury Stock 220,000Contributed Capital from Treasury Stock Transactions 80,000

Treasury Stock

10,000 shares × $30 = $300,000

10,000 shares × $22 cost = $220,000

On December 3, Wal-Mart reissued 10,000 shares of the treasury stock at $30 per share.

The journal entry for December 3 is . . .


Accounting for Cash Dividends

Declared by board of directors.

Not legally required.

Creates liability at declaration.

Requires sufficient Retained Earnings

and Cash.


Dividend DatesDeclaration date

$Board of directors declares the dividend.

$Record a liability.

GENERAL JOURNAL Page 12

Date DescriptionPost. Ref. Debit Credit

Reta ined Earnings XXXDividends Payable XXX


Dividend Dates

Date of RecordStockholders holding shares on this date

will receive the dividend. (No entry)

X


Dividend DatesDate of Payment

Record the payment of the dividend to stockholders.

GENERAL JOURNAL Page 12

Date DescriptionPost. Ref. Debit Credit

Dividends Payable XXXCash XXX


Dividends on Preferred Stock

!Current Dividend Preference: The current preferred dividends must be paid before paying any dividends to common stock.

"Cumulative Dividend Preference: Any unpaid dividends from previous years(dividends in arrears) must be paid before common dividends are paid.

!Current Dividend Preference: The current preferred dividends must be paid before paying any dividends to common stock.

"Cumulative Dividend Preference: Any unpaid dividends from previous years(dividends in arrears) must be paid before common dividends are paid.



If the preferred stock isnoncumulative, any dividends not declared in previous years

are lost permanently.

If the preferred stock isnoncumulative, any dividends not declared in previous years

are lost permanently.



Kites, Inc. has the following stock outstanding:

Common stock: $1 par, 100,000 sharesPreferred stock: 3%, $100 par, cumulative, 5,000 shares

Preferred stock: 6%, $50 par, noncumulative, 3,000 shares

Dividends were not paid last year. In the current year, the board of directors

declared dividends of $50,000. How much will each class of stock receive?


Dividends on Preferred StockTotal dividend declared 50,000$ Preferred stock (cumulative)

RemainderPreferred stock (noncumulative)

RemainderCommon stock

Remainder


Dividends on Preferred StockTotal dividend declared 50,000$ Preferred stock (cumulative)Arrearage ($100 par × 3% × 5,000 shares) 15,000$ Current Yr. ($100 par × 3% × 5,000 shares) 15,000 30,000 Remainder 20,000$ Preferred stock (noncumulative)

RemainderCommon stock

Remainder


Dividends on Preferred StockTotal dividend declared 50,000$ Preferred stock (cumulative)Arrearage ($100 par × 3% × 5,000 shares) 15,000$ Current Yr. ($100 par × 3% × 5,000 shares) 15,000 30,000 Remainder 20,000$ Preferred stock (noncumulative)Current Yr. ($50 par × 6% × 3,000 shares) 9,000 Remainder 11,000$ Common stock

Remainder


Dividends on Preferred StockTotal dividend declared 50,000$ Preferred stock (cumulative)Arrearage ($100 par × 3% × 5,000 shares) 15,000$ Current Yr. ($100 par × 3% × 5,000 shares) 15,000 30,000 Remainder 20,000$ Preferred stock (noncumulative)Current Yr. ($50 par × 6% × 3,000 shares) 9,000 Remainder 11,000$ Common stockCurrent Yr. ($11,000 Remainder) 11,000 Remainder 0$


DividendsQuestion

On June 1, 2000 a corporation’s board of directors declared a dividend for the 2,500 shares

of its $100 par value, 8% preferred stock. The dividend will be paid on July 15. Which of the following will be included in the July 15 entry?

a. Debit Retained Earnings $20,000.b. Debit Dividends Payable $20,000.c. Credit Dividends Payable $20,000.d. Credit Preferred Stock $20,000.


On June 1, 2000 a corporation’s board of directors declared a dividend for the 2,500 shares

of its $100 par value, 8% preferred stock. The dividend will be paid on July 15. Which of the following will be included in the July 15 entry?

a. Debit Retained Earnings $20,000.b. Debit Dividends Payable $20,000.c. Credit Dividends Payable $20,000.d. Credit Preferred Stock $20,000.

DividendsQuestion


July 15 Dividends Payable 20,000Cash 20,000

$100 × 8% = $8 dividend per share

$8 × 2,500 = $20,000 total dividend


Accounting for Stock Dividends

Distribution of additional sharesof stock to stockholders.

No change in total stockholders’ equity.

All stockholders retain same percentage ownership.

No change in par values.


Stock dividend < 25%Stock dividend < 25%

Stock Dividends

Stock dividend > 25%Stock dividend > 25%

Record at currentmarket value

of stock.

Record at currentmarket value

of stock.

Record atpar valueof stock.

Record atpar valueof stock.

Small Large


Stock Splits

Distributions of 100% or more

of stock to stockholders.

Ice Cream Parlor

Banana Splits On Sale Now


Stock SplitsAssume that a corporation had 5,000 shares of $1 par value common stock outstanding

before a 2–for–1 stock split.Before

SplitAfter Split

Common Stock Shares 5,000

Par Value per Share 1.00$

Total Par Value 5,000$


Stock SplitsAssume that a corporation had 5,000 shares of $1 par value common stock outstanding

before a 2–for–1 stock split.

Increase

Decrease

No Change

Before Split

After Split

Common Stock Shares 5,000 10,000

Par Value per Share 1.00$ 0.50$

Total Par Value 5,000$ 5,000$


Restrictions on Retained Earnings

If I loan you $150,000, I will want you to restrict your

retained earnings. Why would youwant to do that?


Restrictions on Retained Earnings

Because I want to restrict the amount you can pay

out in dividends.


Accounting and Reporting for Unincorporated Businesses

Corporation (Stockholders' Equity)

Sole Proprietorship (Owner's Equity)

Partnership (Partners' Equity)

Equity Accounts

Capital Stock Doe, Capital Able, Capital Baker, Capital

Contributed Capital in Excess of Par

Not used Not used

Retained Earnings Not used Not usedDistributions

to OwnersDividends Paid Doe, Drawings Able, Drawings

Baker, Drawings Closing Entries

Income Summary (closed to Retained

Earnings)

Income Summary (closed to Doe, Capital)

Income Summary (closed to Able, Capital

and Baker, Capital)Income

StatementRevenues, expenses,

gains and lossesSame Same

Balance Sheet

Assets and liabilities Same Same


End of Chapter 11

C’mon Chester! With your smarts and my savvy, we

could make a great partnership!!

chapter 11 · management management compensation package includes salary and stock options. stock...

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