chapter 11, slide #1 ch.11 shareholders’ equity prof. j. wang

Chapter 11, Slide #1

Ch.11Shareholders’ Equity

Prof. J. Wang


Part I: Introduction

Assets = Liabilities + Owners’ Equity


Part I: Introduction

• Equity v. Debt Financing– Advantage of equity financing:

• flexibility

– Advantage of debt financing: • tax deductible,

• Benefit shareholders if the borrowing rate is lower than the rate of return using the borrowed money

• Shareholders’ ownership interest is not diluted


Expanded Accounting Equation

Assets = Liabilities + Owners’ Equity

Assets = Liabilities + Stockholders’ Equity

Contributed Capital

RetainedEarningsCh.9&10

Ch.11


Part II: Contributed Capital

Common Stock• Basic stock of corporation• Normally carries voting rights

Preferred Stock• Optional• No voting rights


Preferred Stock

In exchange for giving up voting rights, have dividend preference over common stock

Stated dividend rate• Percentage of the

stock’s par value• Per-share amount

Preferred dividends usually are cumulative

LO2

$100 par,

7% preferred stock


Outstanding: notrepurchased or retired

Issued: sold or distributed

Number of Shares of StockAuthorized

1,000

MaximumAllowable


Par Value

“Legal capital” Arbitrary amount

(usually small) stated on stock certificate

Also called “stated value”

Certificate of Stock

$1.00 Par Value


Additional Paid-in Capital

Amount received in excess of par when stock was issued


$1.00 Par Value

15


Stock Issued for Cash

Journal entry:Cash 15,000 Common Stock 10,000 Additional Paid-In Capital—Common 5,000To record the issuance of 1,000 shares of $10 common stock at $15 per share.

LO3

1,000 shares of $10 par value

stock sold for $15 per

share

Common Stock $ 10,000( $10 par value × 1,000 shares)

Additional Paid-In Capital $5,000 (($15 – $10) × 1,000 shares)

Example:


Stock Issued for Noncash Consideration

Record at fair market value of consideration given or received, whichever is more readily determinable

Certificate of StockTitle

to land, building,

etc.


Stock Issued for Non-cash Assets

Journal entry:Land 15,000 Common Stock 10,000 Additional Paid-In Capital—Common 5,000To record the issuance of 1,000 shares of $10 common stock for land.

LO3

issued1,000 shares of $10 par value

stock For land with a fair

value of $15,000

Common Stock $ 10,000( $10 par value × 1,000 shares)

Additional Paid-In Capital $5,000

Example:


Part III: Retained Earnings


Retained Earnings Net income retained in the business

(not paid out as dividends) since its inception

Reinvested in a variety of assets (not necessarily liquid)


Retained Earnings

• Increases when net income is earned

• Decreases when dividends are paid


Retained Earnings Connects the Income Statement and the Balance Sheet

Statement of Retained Earnings Retained Earnings, Beginning Balance $ xxxAdd: Net Income incDeduct: Dividends xxxRetained Earnings, Ending Balance $ end

Balance Sheet Total Assets $ xxxTotal Liabilities xxxStockholders’ Equity xxxRetained Earnings endTotal Liabilities and Stockholders' Equity $ xxx

Income Statement Revenues $ xxxLess: Expenses xxxNet Income $ inc


Cash Dividend Requirements

Sufficient cash Positive retained

earnings


Cash Dividends

Paidto

Stockholderson date of record

Date of declaration

1 2 3

4 5 6 7 8 9 10

11 12 13 14 15 16 17

18 19 20 21 22 23 24

25 26 28 29 30 3127

Payment date

on1 2 3

4 5 6 7 8 9 10

11 12 13 14 15 16 17

18 19 20 21 22 23 24

25 26 28 29 30 3127

dividend check forDate

Dept.. of Treasurer

Jane Doe


Dividends

Journal entry required to record:

(1) 12/31/06, $5,000 cash dividends declared

(2) 1/15/07, $5,000 cash dividends were paid

Reduce retained earnings

12/31/06 1/15/07

Paydividends


Recording Cash Dividends

Retained Earnings 5,000

Cash Dividend Payable 5,000

To record the declaration of a cash dividend on 12/31/06.

Cash Dividend Payable 5,000

Cash 5,000

To record the payment of a cash dividend on 1/15/07.

dividend check forDate

Dept.. of Treasurer

Jane Doe


• If the company has preferred stocks outstanding then dividends must be divided between common and preferred shareholders

• If preferred dividends are cumulative, preferred shareholders will receive dividends in arrears and for the current year before common shareholders receive any dividends.

• If preferred dividends are non-cumulative, preferred shareholders will only receive dividends for the current year before common shareholders receive theirs.


Allocation of Cash Dividendswhen preferred stock is cumulative

1. Distribute dividends in arrears, if any, to preferred

2. Distribute current year’s dividends to preferred

3. Distribute remainder to common (or to both if preferred is participating)

1 2 3

4 5 6 7 8 9 10

11 12 13 14 15 16 17

18 19 20 21 22 23 24

25 26 28 29 30 3127

20041 2 3

4 5 6 7 8 9 10

11 12 13 14 15 16 17

18 19 20 21 22 23 24

25 26 28 29 30 3127

20051 2 3

4 5 6 7 8 9 10

11 12 13 14 15 16 17

18 19 20 21 22 23 24

25 26 28 29 30 3127

2006

1 2 3

4 5 6 7 8 9 10

11 12 13 14 15 16 17

18 19 20 21 22 23 24

25 26 28 29 30 3127

2007

LO5


Cash Dividends Example

Stricker Company declares a $70,000 dividend in 2007 (no dividends were paid in 2005 or 2006). There are 10,000 shares of $10 par, 8% preferred stock and 40,000 shares of $5 par common stock outstanding.



To Preferred To Common

Step 1: Distribute current-year dividend to preferred (10,000 shares × $10 par × 8% × 1 year) $8,000Step 2: Distribute remaining dividend to common ($70,000 – $8,000) $62,000Total allocated $8,000 $62,000

Noncumulative Preferred Stock

$0.80per

share

$1.55per

share



To Preferred To Common

Step 1: Distribute dividends in arrears to preferred (10,000 shares × $10 par × 8% × 2 years) $16,000Step 2: Distribute current-year dividendto preferred (10,000 shares × $10 par ×8% × 1 year) 8,000Step 3: Distribute remainder to common($70,000 – $8,000) $46,000Total allocated $24,000 $46,000

Cumulative Preferred Stock

$0.80per

share

$1.55per

share


Stock Dividends

Reasons:• Insufficient cash• Market price reduction• Nontaxable to recipients

Certificate of StockCertificate of Stock



Issue of additional shares proportionately to existing stockholders

LO6


Stockholders’ Equity:Common stock, $10 par, 5,000 shares

issued and outstanding $ 50,000Additional paid-in capital—Common 30,000 Retained earnings 70,000

Total stockholders’ equity $150,000

Assume Shah Company declares a 10% stock dividend;500 additional shares will be issued. Assume that market value

Per share at the time is $40.

Before Dividend

Small Stock Dividend Example



Contributed Capital

RetainedEarnings

+$20,000 - $20,000


Stockholders’ Equity: Common stock, $10 par, 5,500 shares $ 50,000 $ 55,000Additional paid-in capital—Common 30,000 45,000Retained earnings 70,000 50,000

Total stockholders’ equity $150,000 $150,000

$20,000 ($40*500) market value deducted from retained earnings; allocated between Common

Stock (initially Common Stock Dividend Distributable) ($10*500) and Additional Paid-In

Capital ($30*500).

Before After


++–




Before After


++–

Total S/E is unchanged





Assume Shah Company declares 100% stock dividendThat is, additional 5,000 shares will be issued

Before Dividend

Large Stock Dividend Example


Stockholders’ Equity: Common stock, $10 par, 10,000 shares $ 50,000 $100,000Additional paid-in capital—Common 30,000 30,000Retained earnings 70,000 20,000


Retained earnings is reduced by the total par value It’s recorded in the Common Stock account at par. Additional Paid-In Capital account is unaffected.

Before After


+–


Stockholders’ Equity: Common stock, $10 par, 10,000 shares $ 50,000 $100,000Additional paid-in capital—Common 30,000 30,000Retained earnings 70,000 20,000


Before After


+–

Total S/E is unchanged


Stock Splits

Results in additional issuance of shares Reduces par value per share No change in Stockholders’ Equity

accounts

Certificate of Stock$3 par value


Certificate of Stock$1 par value

LO 7


Stock Splits

Not recorded in accounts

Reduce market price per share and make the stock more accessible to a wider range of investors Disclose

in notes





Assume Shah Company declares 2-for-1 stock split

Before Split

2-for-1 Stock Split Example




Before After

2-for-1 Stock Split Example

All accounts are unchangedOnly disclosures

are affected


Part IV: Treasury Stock

Company buys back its own stock Contra-equity account (debit balance) Not outstanding (no voting rights)


LO4


Reasons for Repurchasing Stock

Provide for employee bonuses or benefit plans

Maintain a favorable market price Improve financial ratios Maintain control of ownership Prevent unwanted takeover or buyout

attempts


• For example, the company purchased 100 shares of its own outstanding stock at $25 per share

Dr. Treasury Stock 2,500

Cr. Cash 2.500


-$2,500 -$2,500


Presentation of Treasury Stock

Common stock, $10 par value, 1,000 shares issued, 900 outstanding $10,000

Additional paid-in capital—Common 12,000Retained earnings 15,000Total contributed capital and retained earnings 37,000Less: Treasury stock, 100 shares at cost ($25 per share) 2,500


chapter 11, slide #1 ch.11 shareholders’ equity prof. j. wang

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