chapter 13 stockholders’ equity - brasher...

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Chapter 13Stockholders’

Equity

Chapter 13 Learning Objectives

1. Identify the characteristics of a corporation

2. Journalize the issuance of stock

3. Account for the purchase and sale of treasury stock

4. Account for cash dividends, stock dividends, and stock splits

13-2© 2018 Pearson Education, Inc.

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Chapter 13 Learning Objectives

5. Prepare a corporate income statement including earnings per share

6. Explain how equity is reported for a corporation

7. Use earnings per share, rate of return on common stockholders’ equity, and the price/earnings ratio to evaluate business performance


Learning Objective 1

Identify the characteristics of a corporation


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WHAT IS A CORPORATION?

• A corporation is a business organized under state law that is a separate legal entity.

• Corporations dominate business activity in the United States.

• Most well-known companies are corporations.


Characteristics of Corporations

• Unique characteristics of corporations:– Separate legal entity– Number of owners– No personal liability of the owner(s)– Lack of mutual agency– Indefinite life– Taxation– Capital accumulation


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Characteristics of Corporations


Stockholders’ Equity Basics

• The maximum number of shares of stock a corporation may issue is called authorized stock.

• Issued stock has been issued by the corporation.

• Stock held by the stockholders is called outstanding stock.

• Stockholders are issued stock certificates. • Capital stock represents a stockholder’s

ownership. 13-8© 2018 Pearson Education, Inc.

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Stockholders’ Rights

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• A stockholder has four basic rights:1. Vote―Each share of basic ownership in the

corporation carries one vote. 2. Dividends―Stockholders receive a

proportionate part of any dividend declared and paid.

3. Liquidation―Stockholders receive their proportionate share of any assets remaining after liquidation.

4. Preemptive right―Stockholders have a right to maintain their proportional ownership.

© 2018 Pearson Education, Inc.

Capital Stock

• Corporations issue different classes of stock:– Common stock represents basic ownership.– Preferred stock gives owners certain

advantages over common stock.• Stock may carry a par value or may be

no-par stock. • Stated value stock is no-par stock that has

been assigned an amount similar to par value.


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Stockholders’ Equity

• A corporation’s equity is called stockholders’ equity.

• The two basic sources of stockholders’equity are: – Paid-in capital represents amounts received

from stockholders for stock.– Retained earnings is equity earned by

profitable operations that is not distributed to stockholders.



Journalize the issuance of stock


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HOW IS THE ISSUANCE OF STOCK ACCOUNTED FOR?

• Companies raise capital by issuing stock. • A company can sell its stock directly to

stockholders, or it can use the services of an underwriter.

• Stocks of public companies are bought and sold on a stock exchange, such as the New York Stock Exchange (NYSE) or NASDAQ Stock Market.

• The issue price is the amount a corporation receives from issuing stock.


Issuing Common Stock at Par Value

Smart Touch Learning’s common stock carries a par value of $1 per share, and the charter authorizes 20,000,000 shares of common stock. The stock issuance of 15,000 shares of stock at par value is recorded as:


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Issuing Common Stock at a Premium

Smart Touch Learning issues an additional 3,000 shares for $5 per share. The $4 difference between the issue price ($5) and the par value ($1) is a premium, recorded in Paid-in Capital in Excess of Par.


Issuing Common Stock at a Premium


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Issuing No-Par Common Stock

Smart Touch Learning’s common stock is no-par. Assume that the company issues 15,000 shares for $1 and 3,000 shares for $5.


Issuing No-Par Common Stock


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Issuing Stated Value Common Stock

Smart Touch Learning issues 3,000 shares of $1 stated value stock for $5 per share. Accounting for stated value stock is similar to accounting for par value stock.


Issuing Common Stock for Assets Other Than Cash

Smart Touch Learning receives furniture with a market value of $18,000 in exchange for 5,000 shares of its $1 par common stock. • It is recorded at the market value of either the

stock issued or of the asset received, whichever is more determinable.


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Issuing Preferred Stock

Smart Touch Learning issues 1,000 shares of its $50 par, 6% preferred stock on January 3 at $55 per share.


Issuing Preferred Stock


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Account for the purchase and sale of treasury stock


HOW IS TREASURY STOCK ACCOUNTED FOR?

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• Treasury stock is a company’s stock that it has previously issued and later reacquired.

• Companies purchase treasury stock to:– Increase net assets by buying low and selling

high– Support the company’s stock price– Avoid a takeover– Reward valued employees with stock


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Treasury Stock Basics

• The basics of accounting for treasury stock:– The Treasury Stock account has a normal debit

balance. Treasury Stock is a contra equity account.

– Treasury stock is recorded at cost, without reference to par value.

– The Treasury Stock account is reported beneath Retained Earnings on the balance sheet as a reduction to equity.


Purchase of Treasury Stock

On March 31, Smart Touch Learning purchases 1,000 shares of previously issued common stock, paying $5 per share.


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Sale at Cost

Smart Touch Learning sells 100 of the treasury shares on April 1 for $5 each.


Smart Touch Learning resells 200 of its treasury shares for $6 per share on April 2. (Recall that the cost was $5 per share.)


Sale Above Cost

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On April 3, Smart Touch Learning resells 200 treasury shares for $4.30 each.


Sale Below Cost

What happens if Smart Touch Learning resells an additional 200 treasury shares for $4.50 each on April 4?


Sale Below Cost

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Sale of Treasury Stock


How many common shares are outstanding on April 4?• The 23,000 common

shares previously issued minus 300 treasury shares equals 22,700 outstanding common shares.


Sale of Treasury Stock

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Retirement of Stock

• A corporation may retire its stock by canceling the stock certificates.

• Retired stock cannot be reissued.• To repurchase previously issued stock for

retirement, we debit the stock accounts and credit Cash. – This removes the retired stock from the

company’s books.– It also reduces total assets and total

stockholders’ equity.



Account for cash dividends, stock dividends, and stock splits


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HOW ARE DIVIDENDS AND STOCK SPLITS ACCOUNTED FOR?

• A profitable corporation may make distributions to stockholders in the form of dividends.

• Dividends can be paid in the form of cash, stock, or other property.

• Legal capital refers to the portion of stockholders’ equity that cannot be used for dividends.


Cash Dividends

• Three dividend dates are relevant:

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Declaration Declaration date

• The board of directors announces the intention to pay the dividend, and a liability is created.

Date of Date of record

• This is the date the corporation records the stockholders that will receive dividend checks.

Payment Payment date

• This is the date the dividend is paid to the stockholders.


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Declaring and Paying Dividends―Common Stock

On May 1, Smart Touch Learning declares a $0.05 per share cash dividend on 22,700 outstanding shares of common stock.



• On May 15, the date of record, no journal entry is recorded.

• On May 30, Smart Touch Learning pays the dividend to its shareholders.


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At the end of the accounting period, Smart Touch Learning closes the Cash Dividends account to Retained Earnings.


Declaring and Paying Dividends―Preferred Stock

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• The cash dividend rate on preferred stock is often expressed as a percentage of the preferred stock par value, such as 6%.

• Sometimes, cash dividends on preferred stock are expressed as a flat dollar amount per share, such as $3 per share.


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Greg’s Games, Inc. has 1,000 outstanding shares of 6%, $50 par value preferred stock. The dividend is computed as follows:



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• A preferred stock dividend in arrears is a dividend that has not been paid for the year.

• Preferred stock can be:– Cumulative preferred stock―Preferred stock whose

owners must receive all dividends in arrears plus the current year dividends before the corporation pays dividends to the common stockholders

– Noncumulative preferred stock―Preferred stock whose owners do not receive passed dividends


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Greg’s Games, Inc. has 1,000 outstanding shares of 6%, $50 par value cumulative preferred stock. In 2018 the business did not pay any cash dividends. On September 6, 2019, Greg’s Games declares a $50,000 total dividend.



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Greg’s Games’ entry to record the declaration of this dividend on September 6, 2019:


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Greg’s Games, Inc. has 1,000 outstanding shares of 6%, $50 par value noncumulative preferred stock. In 2018 the business did not pay any cash dividends. On September 6, 2019, Greg’s Games declares a $50,000 total dividend.


Stock Dividends

• A stock dividend is a distribution of a corporation’s own stock to its shareholders.

• Stock dividends have the following characteristics:– They affect only stockholders’ equity accounts. – They have no effect on total stockholders’

equity. – They have no effect on assets or liabilities.


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Why Issue Stock Dividends?

• A company issues stock dividends in order to:– Continue dividends but conserve cash– Reduce the market price per share of its stock– Reward investors


Recording Stock Dividends

• There are three dates for a stock dividend:– Declaration date– Record date– Distribution date

• A small stock dividend is less than 20% to 25% of issued and outstanding stock.

• A large stock dividend is greater than 20% to 25% of issued and outstanding stock.


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Greg’s Games distributes a 5% common stock dividend on 2,000,000 shares issued and outstanding when the market value is $50 per share and par value is $1 per share. Declaration date entry:



On February 25, Greg’s Games distributes the common stock and records the following:


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After the journal entry for the declaration and issuance of the common stock dividend and the closing entry to close Stock Dividends to Retained Earnings, Greg’s Games’ accounts are as follows:




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Recording Stock DividendsOn March 2, Greg’s Games declares a second common stock dividend of 50% when the market value of Greg’s Games’ common stock is $50 per share.


Stock Splits

• A stock split is fundamentally different from a stock dividend.

• A stock split increases the number of issued and outstanding shares of stock.

• A stock split decreases the par value and the market value per share, whereas stock dividends do not affect par value per share.


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Stock Splits

Assume that Greg’s Games has 3,150,000 shares issued and outstanding of $1 par common stock. The market value is $50 per share. Greg’s Games effects a 2-for-1 stock split.

• No formal journal entry is needed. • Instead, the split is recorded in a memorandum entry,

an entry in the journal that notes a significant event but has no debit or credit amount.


Cash Dividends, Stock Dividends, and Stock Splits Compared


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Prepare a corporate income statement including earnings per share



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HOW IS THE COMPLETE CORPORATE INCOME STATEMENT PREPARED?

• Continuing operations:– These operations should continue from period to period.– Income from continuing operations helps investors make

predictions about future earnings.

• Discontinued operations:– These gains and losses occur when a company sells or

disposes of an identifiable division.– They are reported separately from continuing operations

because this type of disposal does not occur frequently.


Earnings per Share

• Earnings per share (EPS) is the most widely used of all business statistics.

• EPS reports the amount of net income (loss) for each share of the company’s outstanding common stock.

• Earnings per share is calculated as net income minus preferred dividends divided by the weighted average number of common shares outstanding.


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Explain how equity is reported for a corporation


HOW IS EQUITY REPORTED FOR A CORPORATION?

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• The statement of retained earnings reports how the company’s retained earnings balance changed from the beginning of the period to the end of the period.

• Companies can report a negative amount in retained earnings. This is called a deficit.


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Statement of Retained Earnings


Appropriations of Retained Earnings

• Cash dividends and treasury stock purchases require a cash payment.

• Banks often require a company to maintain a minimum level of stockholders’equity.

• Appropriations of retained earnings are retained earnings restrictions recorded by journal entries.


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Prior-Period Adjustments

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• Occasionally a company may make an accounting error as a result of mathematical mistakes or other errors not discovered until the following period.

• Corrections to Retained Earnings for errors of an earlier period are called prior-period adjustments.


Prior-Period Adjustments


Mountain Home, Inc. recorded $30,000 of salaries expense for 2018. The correct amount of salaries expense was $40,000. In 2019, Mountain Home paid the extra $10,000 in salaries owed for the prior year.

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Statement of Stockholders’ Equity

• The statement of stockholders’ equity is another option for reporting the changes in stockholders’ equity of a corporation.

• It reports the changes in all stockholders’ equity accounts.


Statement of Stockholders’ Equity


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Use earnings per share, rate of return on common stockholders’ equity, and the price/earnings ratio to evaluate business performance


HOW DO WE USE STOCKHOLDERS’EQUITY RATIOS TO EVALUATE BUSINESS

PERFORMANCE?

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• Investors are constantly comparing companies’ profits.

• Three important ratios are used for comparison:– Earnings per share (EPS)– Rate of return on common stockholders’ equity– Price/earnings ratio


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Earnings per Share

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• The final segment of a corporate income statement reports the company’s earnings per share (EPS).

• EPS reports the amount of net income (loss) for each share of the company’s outstanding common stock.


Earnings per Share

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Kohl’s Corporation’s Fiscal 2015 Annual Report reports the following amounts:

Kohl’s earnings per share for fiscal 2015:


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Price/Earnings Ratio

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• The price/earnings ratio is the ratio of the market price of a share of common stock to the company’s earnings per share.

• This ratio tells investors how much they should be willing to pay for $1 of a company’s earnings.

• Assuming that Kohl’s Corporation has a market price of $37.00 per share of common stock, Kohl’s price/earnings ratio for fiscal year 2015 is:


Rate of Return on Common Stockholders’ Equity

• Rate of return on common stockholders’ equity, often shortened to return on equity, shows the relationship between net income to common stockholders and their average common equity invested in the company.

• For Kohl’s Corporation the rate of return on common stockholders’ equity for fiscal year 2015:


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chapter 13 stockholders’ equity - brasher...

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