CHAPTER 18 : Shareholders’ Equity CHAPTER 18 : Shareholders’ Equity LEARNING OBJECTIVES:LO18-1 Describe the components of shareholders’ equity and explain how they are reported in a statement of shareholders' equity.

LO18-2 Describe comprehensive income and its components.

LO18-3 Understand the corporate form of organization and the nature of stock. (SELF-STUDY)

LO18-4 Record the issuance of shares when sold for cash and noncash consideration.

LO18-5 Distinguish between accounting for retired shares and treasury shares.

LO18-6 Describe retained earnings and distinguish it from paid-in capital.

LO18-7 Explain the basis of corporate dividends, including the similarities and differences between cash and property dividends.

LO18-8 Explain stock dividends and stock splits and we account for them.

LO18-9 Discuss the primary differences between U.S. GAAP and IFRS with respect to accounting for shareholders’ equity. (SELF-STUDY)

18-2

The Nature of Shareholders’ Equity

Assets – Liabilities = Shareholders’ Equity

Shareholders’ EquityPaid-in Capital

Retained Earnings

Amounts earnedby corporation

Amounts investedby shareholders

Accumulated OtherComprehensive Income

Other gains and

losses not

included in net

income

Sources ofShareholders’

Equity

Net Assets

18-3

Financial Reporting Overview

18-4

Accumulated OtherComprehensive Income

Deferred gains

(losses) from derivatives.

Deferred gains

(losses) from derivatives.

Gains (losses) from

and amendments

to postretireme

nt benefit plans.

Gains (losses) from

and amendments

to postretireme

nt benefit plans.

Gains (losses) from

foreign currency

translations.

Gains (losses) from

foreign currency

translations.

Net holding gains (losses)

on investments.

Net holding gains (losses)

on investments.

Accumulated other comprehensive Accumulated other comprehensive income includes four types of gains and income includes four types of gains and

losseslosses not included in net income. not included in net income.

Accumulated other comprehensive Accumulated other comprehensive income includes four types of gains and income includes four types of gains and

losseslosses not included in net income. not included in net income.

18-5

There are 2 options for reporting

comprehensive income created during the reporting period.

There are 2 options for reporting

comprehensive income created during the reporting period.

The accumulated amount of

comprehensive income is reported as a separate item of

shareholders’ equity in the balance sheet.

The accumulated amount of

comprehensive income is reported as a separate item of

shareholders’ equity in the balance sheet.

As an additional

section of the income

statement.

As an additional

section of the income

statement.

As a separate statement

immediately following the

income statement

As a separate statement

immediately following the

income statement

Accumulated OtherComprehensive IncomeComprehensive income is reported periodically Comprehensive income is reported periodically

as it is created and also is reported as a as it is created and also is reported as a cumulative amount. cumulative amount.

Comprehensive income is reported periodically Comprehensive income is reported periodically as it is created and also is reported as a as it is created and also is reported as a

cumulative amount. cumulative amount.

18-6The Corporate Organization (SELF STUDY)

Continuousexistence

Easy ownership transfer

Limitedliability

Easy toraise

capital

Advantages of a corporation

Disadvantages of a corporation

Doubletaxation

Governmentregulation

18-7Types of Corporations (SELF STUDY)

Publicly-held corporationswhose shares are widelyowned by the general public.

Privately-held corporationswhose shares are owned by only a few individuals.

Not-for-profit corporations includehospitals, charities, and governmentagencies such as FDIC.

18-8

Hybrid Organizations (SELF STUDY)

S Corporation Limited liability protection of a corporation. Maximum number of owners.

Limited liability company Limited liability protection of a corporation. All owners may be involved in management

without losing limited liability protection. No limit on number of owners.

Limited liability partnership Owners are liable for their own actions but

not entirely liable for actions of other partners.

S Corporation Limited liability protection of a corporation. Maximum number of owners.

Limited liability company Limited liability protection of a corporation. All owners may be involved in management

without losing limited liability protection. No limit on number of owners.

Limited liability partnership Owners are liable for their own actions but

not entirely liable for actions of other partners.

Doubletaxationavoided.

18-9

Board of directors appoint officers.

The Model Business Corporation Act (SELF STUDY)

Articles of incorporationare filed with the state.

Board of directors elected by

shareholders.Shares of

stock issued.

State issues a corporate charter.

CorporateCharter

Nature and location of business activities. Number and classes of shares authorized.

18-10

Fundamental Share Rights

Right to sharein distribution ofassets if company

is liquidated.

Right to sharein profits whendividends are

declared.

Right to vote.

Preemptiveright to maintain

percentageownership.

18-11

Issued shares

are authorized shares of stock

that have been sold.

Unissued shares are authorized shares of stock

that never have

been sold.

Authorized shares are the maximum

number of shares of capital stock that

can be sold to the public.

Authorized, Issued, andOutstanding Shares

18-12

AuthorizedShares

UnissuedShares

TreasuryShares

OutstandingShares

RetiredShares

Authorized, Issued, andOutstanding Shares

18-13

Capital StockPar value stock

Dollar amount per share is stated in the corporate charter.

Par value has no relationship to market value.

No-par stock Dollar amount per share

is not designated in corporate charter.

Corporations can assign a stated value per share (treated as if par value).

Legal capital is . . . The portion of shareholders’ equity that must be

contributed to the firm when stock is issued. The amount of capital, required by state law, that

must remain invested in the business. Refers to par value, stated value, or full amount

paid for no-par stock.

18-14

Capital Stock

Common stock is the basic voting stock of the corporation. It ranks after preferred stock for

dividend and liquidation distribution. Dividends are determined by the board of

directors.

Dividend and liquidationDividend and liquidation preference over preference overcommon stock.common stock.

Generally does notGenerally does nothave voting rights.have voting rights.

Usually has aUsually has apar or stated value.par or stated value.

May be convertible,May be convertible,callable, and/orcallable, and/or

redeemable.redeemable.

PreferredStock

18-15Preferred Stock Dividends

Are usually stated as a percentage of the par or stated value. May be cumulative or noncumulative. May be partially participating, fully participating, or nonparticipating.Unpaid Dividends on

Cumulative PREFERRED stocks must be paid in full

before any distributions to common stock.

Dividends in arrears are not liabilities, but the per share and aggregate amounts must be

disclosed.

Brief Exercise 18–5

Brief Exercise 18–5

MLS’s common shareholders’ will receive dividends of $18 million as a result of the 2013 distribution.

Preferred Unpaid Preferred Common Dividends

2011 $20 million* $4 million $02012 20 million** $4 million $02013 32 million*** $0 $18 million (remainder) Preferred Dividend Preference = $400 Million * 6% = $24 million

* $24 - $20 = $4 million dividends in arrears.

** $24 - $20 = $4 million dividends in arrears.

*** $8 million dividends in arrears plus the $24 million current preference.

18-17

Shares Issued for Cash

10,000 shares of stock are issued for $100,000 cash.

$1 Par Value

No ParValue

No Par,$1 Stated

Value

Cash ....................................................... 100,000 Common stock, par value .............. 10,000 Paid-in capital – excess of par …… 90,000To record issue of common stock.

Cash ....................................................... 100,000 Common stock ............................. 100,000To record issue of common stock.

Cash ................................................................... 100,000 Common stock, stated value ..................... 10,000 Paid-in capital – excess of stated value …. 90,000To record issue of common stock.

18-18Shares Issued for

Noncash Consideration

Apply the general valuation principle by using fair value of stock given up

or fair value of asset received, whichever is more clearly evident.

If market values cannot be determined, use appraised values.

Apply the general valuation principle by using fair value of stock given up

or fair value of asset received, whichever is more clearly evident.

If market values cannot be determined, use appraised values.

18-19More Than One Security

Issued for a Single Price

Allocate the lump-sum received based on the relative fair values of the two securities.

If only one fair value is known, allocate a portion of the lump-sum received based on that fair value and allocate the remainder to the other security.

Toys Inc. issued 5,000 shares of common stock, $10 par value, and 3,000 shares of preferred stock, $5 par value, for $450,000. The market values of

the common stock andpreferred stock were $55 and $75, respectively.

Calculate the additional paid-incapital for each class of stock.

18-20More Than One Security Issued

for a Single Price

Cash ............................................................................ 450,000 Common stock, $10 par ..................................... 50,000 Paid-in capital – excess of par common ……….. 197,500 Preferred stock, $5 par 15,000 Paid-in capital – excess of par preferred ………. 187,500 To record issue of common and preferred stock.

Market* % Allocation** Par^ Excess^^Common Stock 275,000$ 55% 247,500$ 50,000$ 197,500$ Preferred Stock 225,000 45% 202,500 15,000 187,500

Total 500,000$ 100% 450,000$ 65,000$ 385,000$

* Market Value: ^ Par Value: Common: $55 × 5,000 shares Common: $10 × 5,000 shares Preferred: $75 × 3,000 shares Preferred: $5 × 3,000 shares

**Allocation: ^^Excess: Common: $450,000 × 55% Common: $247,500 - $50,000 par Preferred: $450,000 × 45% Preferred: $202,500 - $15,000 par

18-21Share Issue Costs

Share issue costs reduce net proceedsfrom selling shares, resulting in a lower

amount of additional paid-in capital.EXERCISE 7

Exercise 18–7

Requirement 1 ($ in millions):

Cash ($424 million – 2 million) 422Common stock (15 million shares at $1 par per share) 15Paid-in capital—excess of par (difference) 407

 Requirement 2 In recording the sale of shares above, the cost of services related to the sale reduced the net proceeds from selling the shares.

Since paid-in capital—excess of par is credited for the excess of the proceeds over the par amount of the shares sold, the effect of share issue costs is to reduce the amount credited to that account.

On the other hand, the costs associated with a debt issue are recorded in a separate “debt issue costs” account and amortized to expense over the life of the debt.

18-23

Share Buybacks

A corporation might reacquire shares of its stock to . . . support the market price. increase earnings per share. distribute in stock option plans. issue as a stock dividend. use in mergers and acquisitions. thwart takeover attempts.

A corporation might reacquire shares of its stock to . . . support the market price. increase earnings per share. distribute in stock option plans. issue as a stock dividend. use in mergers and acquisitions. thwart takeover attempts.

Companies can account for the

reacquired shares by retiring them or by holding them as

treasury shares.

18-24

Accounting for Retired Shares

When shares are formally retired, we reduce the same capital accounts that were increased when the

shares were issued – common or preferred stock, and additional paid-in capital.

5,000 shares of $2 par value stock that were issued

for $20 per share are reacquired for $17 per share.

Price paid is less than issue price.

Common stock ............................................................ 10,000

Paid-in capital – excess of par common …………….... 90,000 Paid-in capital – share repurchase …………….. 15,000 Cash ……………………………………………….. 85,000 To record repurchase and retirement of common stock.

18-25

Price paid is more than issue price.

Accounting for Retired Shares

5,000 shares of $2 par value stock that were issued

for $20 per share are reacquired for $25 per share.

Common stock ............................................................ 10,000

Paid-in capital – excess of par common ……………….90,000Paid-in capital – share repurchase ……………………..25,000 Cash ……………………………………………….. 125,000 To record repurchase and retirement of common stock.

Reduce Retained Earnings if the Paid-in capital—share repurchase account balance is insufficient.

18-26

Accounting for Treasury Stock

Acquisition of Treasury StockRecorded at cost to acquire.

Resale of Treasury StockTreasury Stock credited for cost.Difference between cost and issuance price is (generally) recorded in paid-in capital—share repurchase.

Treasury stock usually does not have:Voting rights.Dividend rights.Preemptive rights.Liquidation rights.

Treasury stock is reported as an unallocated reductionof total Shareholders’ Equity.

18-27

Accounting for Treasury Stock On 5/1/12, Photos-in-a-Second reacquired 3,000 shares of

its common stock at $55 per share. On 12/3/13, Photos-in-a-Second reissued 1,000 shares of the stock at $75 per share. Which of the following would be included in the 12/3/13 entry?a. Credit Cash for $165,000.b. Debit Treasury Stock for $75,000.c. Credit Treasury Stock for $55,000.d. Credit Cash for $75,000.May 1, 2012:Treasury stock .............................................. 165,000 Cash ................................................... 165,000To record purchase of treasury stock.

December 3, 2013:Cash ............................................................. 75,000 Treasury stock .................................... 55,000 Paid-in capital – share repurchase …. 20,000 To record reissue of treasury stock.

18-28

Where We’re HeadedThe FASB and IASB are working to establish a common

standard for presenting information in the financial statements, An important part of the proposal involves

the organization of elements of the balance sheet, statement of comprehensive income, and statement of

cash flows into a common set of classifications.A key feature of the new format is that each of the financial statements will include classifications by

operating, investing, and financing activities (similar to the current statement of cash flows). Operating and

investing activities will be included within a new category, “business” activities. Each statement also will

include three additional groupings: discontinued operations, income taxes, and multi-category

transactions (if needed).

18-29

Retained Earnings

Represents the undistributed earnings of the company since its inception.

Balance January 1, 2013 $ 106,500 Net income 25,000 Cash dividends (10,000) Balance December 31, 2013 121,500$

The statement of retained earnings may also contain the correction of an accounting error that occurred in the financial statements of a prior period, called a prior period adjustment.

Any restrictions on retained earnings must be disclosed in the notes to the financial statements.

18-30

Accounting for Cash Dividends

Declared by board Declared by board of directors.of directors.

Creates liability Creates liability at declaration.at declaration.

Requires sufficient Requires sufficient Retained Earnings Retained Earnings

and Cash.and Cash.

Declaration date Board of directors declares a $10,000 cash

dividend. Record a liability.

Declaration Date:Retained earnings ........................................ 10,000 Dividends payable .............................. 10,000To record declaration of cash dividend.

Not legally Not legally required.required.

18-31

Date of Record Stockholders holding shares on this date will

receivethe dividend. (No entry)

Dividend Dates

Date of PaymentRecord the dividend payment to stockholders.

Ex-dividend date The first day the shares trade without the right

to receive the declared dividend. (No entry)

Date of Payment:Dividends payable ........................................ 10,000 Cash ……………….............................. 10,000To record payment of cash dividend.

18-32

Property Dividends

Distributions of non-cash assets.

Record at fair value of noncash asset.

Recognize gain or loss for difference between book value and fair value.

Distributions of non-cash assets.

Record at fair value of noncash asset.

Recognize gain or loss for difference between book value and fair value.

18-33

Accounting for Stock Dividends

Distribution of additional shares of stock to owners.

No change in total stockholders’

equity.All stockholders retain

same percentage ownership.

No change inpar values.

Stock dividend < 25%

Stock dividend < 25%

Record at current fair

value of stock.

Record at current fair

value of stock.

SmallStock dividend >

25%Stock dividend >

25%

Record at parvalue of stock.Record at parvalue of stock.

Large

18-34

Accounting for Stock Dividends

CarCo declares and distributes a 20% stock dividend on 5 million common

shares. Par value is $1 and market value is $20. The required journal entry would be:

Retained earnings ..................................................... 20,000,000 Common stock …………………………………. 1,000,000 Paid-in capital – excess of par common …….. 19,000,000To record declaration and distribution of small stock dividend.

5,000,000 shares × 20 % = 1,000,000 shares issued × $20 5,000,000 shares × 20 % = 1,000,000 shares issued × $20 = $20,000,000= $20,000,000

5,000,000 shares × 20 % = 1,000,000 shares issued × $20 5,000,000 shares × 20 % = 1,000,000 shares issued × $20 = $20,000,000= $20,000,000

18-35

Stock splits change the par value per share and the number of shares outstanding, but the total par

value is unchanged, and no journal entry is required.

Stock Splits

Assume that a corporation had 3,000 shares of $2 par value common stock

outstanding before a 2–for–1 stock split.

Increase

Decrease

No Change

Before Split

After Split

Common Stock Shares 3,000 6,000

Par Value per Share 2.00$ 1.00$

Total Par Value 6,000$ 6,000$

18-36Stock Splits Effected in the

Form of Large Stock Dividends

Matrix Inc. declares and distributes a 2-for-1 stock split effected in the form of a 100% stock dividend. The company has 1,000,000, $1 par value common stock outstanding. The stock is trading in the open market for $14 per share.

The per share par value of the shares is not to be changed.

Matrix Inc. declares and distributes a 2-for-1 stock split effected in the form of a 100% stock dividend. The company has 1,000,000, $1 par value common stock outstanding. The stock is trading in the open market for $14 per share.

The per share par value of the shares is not to be changed.

Paid-in capital – excess of par common …................. 1,000,000 Common stock ……………..……………………. 1,000,000To record declaration and distribution of 2-for-1 stocksplit effected in the form of a 100% stock dividend.

18-37

U.S. GAAP vs. IFRS

Capital stock: Common stock. Preferred stock. Paid‐in capital—excess of

par, common. Paid‐in capital—excess of

par, preferred.

Share capital: Ordinary shares. Preference shares. Share premium, ordinary

shares. Share premium,

preference shares.

Terminology Differences

18-38

U.S. GAAP vs. IFRS

Accumulated other comprehensive income: Net gains (losses) on

investment ― AOCI. Net gains (losses) foreign

currency translation —AOCI. Fair value adjustments not

permitted. Retained earnings. Total shareholders’ equity. Presented after liabilities

Reserves:

Investment revaluation reserve.

Translation reserve.

Revaluation reserve.

Retained earnings. Total equity. Often presented before

liabilities.

Terminology Differences

18-39

U.S. GAAP vs. IFRS

Preferred stock normally is reported as equity, but is reported as debt with the dividends reported in the income statement as interest expense if it is “mandatorily redeemable” preferred stock.

Most non-mandatorily redeemable preferred stock (preference shares) also is reported as debt as well as some preference shares that aren’t redeemable. Under IFRS (IAS No. 32), the critical feature that distinguishes a liability is if the issuer is or can be required to deliver cash (or another financial instrument) to the holder.

Distinction between Debt and Equityfor Preferred Stock

18-40

Appendix 18 ─ NOT COVERED

18-41

End of Chapter 18