copyright © 2007 by the mcgraw-hill companies, inc. all rights reserved. shareholders’ equity 18...
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Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Shareholders’ Equity
18Insert Book Cover
Picture
18-2
Learning Objectives
Describe the components of shareholders’ equity and explain how they are reported in a
statement of shareholders’ equity.
18-3
The Nature of Shareholders’ Equity
Assets – Liabilities = Shareholders’ Equity
Net Assets(Residual Interest)
18-4
Sources of Shareholders’ Equity
Shareholders’ Equity
Paid-in Capital
Retained Earnings
Amounts earnedby corporation
Amounts investedby shareholders
Accumulated OtherComprehensive Income
Other gains and losses not included in net income
18-5
The Corporate Organization
Advantages: Ease of raising capital. Ease of ownership transfer. Limited liability. Continuous existence.
Disadvantages: Double taxation. Government regulation.
Advantages: Ease of raising capital. Ease of ownership transfer. Limited liability. Continuous existence.
Disadvantages: Double taxation. Government regulation.
18-6
Types of Corporations
Not-for-profit corporations includehospitals, charities, and government
agencies such as FDIC.
Privately-held corporationswhose shares are owned by
only a few individuals.
Publicly-held corporationswhose shares are widely
owned by the general public.
18-7
Hybrid Organizations
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.
18-8
Formation of a Corporation
Number and classesof shares authorized.
Composition of initialboard of directors.
Nature and locationof business activities.
CorporateCharter
18-9
Formation of a Corporation
Articles of incorporationare filed with the state.
Board of directors elected by
shareholders.
Board of directors appoint officers.
Shares of stock issued.
State issues a corporate charter.
18-10
Fundamental Share Rights
Rightto vote.
Right to sharein distribution of
assets if companyis liquidated.
Right to sharein profits whendividends are
declared.
Preemptiveright to maintain
percentageownership.
18-11
Authorized, Issued, and Outstanding Capital Stock
AuthorizedShares
The maximum number of shares of capital
stock that can be sold to the public is called
the authorized number of shares.
18-12
Issued shares are authorized shares of stock that have been
sold.
Unissued shares are authorized shares of stock that have never been sold.
AuthorizedShares
Authorized, Issued, and Outstanding Capital Stock
18-13
UnissuedShares
TreasuryShares
OutstandingShares
Treasury shares are issued shares that have been reacquired by the
corporation.
IssuedShares
Outstanding shares are issued shares that are
owned by shareholders.Authorized
Shares
Authorized, Issued, and Outstanding Capital Stock
18-14
UnissuedShares
RetiredShares
OutstandingShares
Retired shares assume the same status as
authorized but unissued shares.
Outstanding shares are issued shares that are
owned by stockholders.Authorized
Shares
Authorized, Issued, and Outstanding Capital Stock
18-15
Capital Stock
Par value stock Designated dollar
amount per share stated in the corporate charter.
Par value has no relationship to market value.
Par value stock Designated dollar
amount per share stated in the corporate charter.
Par value has no relationship to market value.
No-par stock Dollar amount per
share not designated in corporate charter.
Corporations can assign a stated value per share (treated as if par value).
No-par stock Dollar amount per
share not designated in corporate charter.
Corporations can assign a stated value per share (treated as if par value).
18-16
Legal capital is . . . The portion of shareholders’ equity that
must be contributed to the firm when stock is issued.
The amount of capital, required bystate law, that must remain investedin the business.
Refers to par value, stated value,or full amount paid for no-par stock.
Legal capital is . . . The portion of shareholders’ equity that
must be contributed to the firm when stock is issued.
The amount of capital, required bystate law, that must remain investedin the business.
Refers to par value, stated value,or full amount paid for no-par stock.
Capital Stock
18-18
The basic voting stock of the corporation.
Ranks after preferred stock for dividend and liquidation distribution.
Dividends determined by the board of directors.
The basic voting stock of the corporation.
Ranks after preferred stock for dividend and liquidation distribution.
Dividends determined by the board of directors.
Common Stock
18-19
Preferred Stock
Dividend andliquidation
preference over common stock.
Dividend andliquidation
preference over common stock.
Generally does nothave voting rights.Generally does nothave voting rights.
Usually has apar or stated value.
Usually has apar or stated value.
May be convertible,callable, and/or
redeemable.
May be convertible,callable, and/or
redeemable.
18-20
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.
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.
Preferred Stock Dividends
18-21
Preferred Stock DividendsCumulative
Unpaid dividends 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.
18-23
Comprehensive Income
Comprehensive income includes four typesof gains and losses that traditionally have
been excluded from net income.
Comprehensive income includes four typesof gains and losses that traditionally have
been excluded from net income.
Net holding gains (losses)
on investments.
Net holding gains (losses)
on investments.
Deferred gains (losses) from derivatives.
Deferred gains (losses) from derivatives.
Net unrecognized
loss on pensions.
Net unrecognized
loss on pensions.
Gains (losses) from foreign
currency translations.
Gains (losses) from foreign
currency translations.
18-24
Comprehensive Income
Components of comprehensive income created during the reporting period:
($ in millions)
Net income $xxxOther comprehensive income: Net unrealized holding gains (losses) on investments (net of tax)† $ x Net unrecognized loss on pensions (net of tax)‡ (x) Deferred gains (losses) from derivatives (net of tax)§ x Gains (losses) from foreign currency translation (net of tax)* x xxComprehensive income $xxx
† Changes in the market value of securities available-for-sale.‡ Reporting a pension liability sometimes requires recording this (described in Chapter 17).
It often is called pension liability adjustment.§ When a derivative designated as a cash flow hedge is adjusted to fair value, the gain or
loss is deferred as a component of comprehensive income and included in earnings later, at the same time as earnings are affected by the hedged transaction (described in the Derivatives Appendix to the text).
* Gains or losses from changes in foreign currency exchange rates. The amount could be an addition to or reduction in shareholders’ equity. (This item is discussed elsewhere in your accounting curriculum.)
18-25
Comprehensive income is reported periodically as it is created and also is reported as a cumulative amount.
Comprehensive income is reported periodically as it is created and also is reported as a cumulative amount.
Comprehensive Income
There are 3 options for reporting comprehensive income created during the
reporting period.
There are 3 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 a separate statement ina disclosure
note.
As a separate statement ina disclosure
note.
As an additional section of the
income statement.
As an additional section of the
income statement.
As part of the statement of
shareholders’ equity.
As part of the statement of
shareholders’ equity.
18-26
Learning Objectives
Record the issuance of shares when sold for cash, for noncash consideration, and by share
purchase contract.
18-27
Issuing Stock for Cash
10,000 shares of $1 par value stock is issued for $100,000 cash.
10,000 shares of $1 par value stock is issued for $100,000 cash.
18-28
Issuing Stock for Cash
10,000 shares of no-par stock is issued for $100,000 cash.
10,000 shares of no-par stock is issued for $100,000 cash.
18-29
Issuing Stock for Cash
10,000 shares of no-par stock, with a stated value of $1 is issued for $100,000 cash.
10,000 shares of no-par stock, with a stated value of $1 is issued for $100,000 cash.
18-30
Issuing Stock for Noncash Assets
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.
18-31More Than One Security Issuedfor 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.
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.
18-32
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 and preferred stock were $55 and $75,
respectively.
Calculate the additional paid-incapital for each class of stock.
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 and preferred stock were $55 and $75,
respectively.
Calculate the additional paid-incapital for each class of stock.
More Than One Security Issuedfor a Single Price
18-33
Market* % Allocation** Par^ Excess^^Common Stock 275,000$ 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
Record the journal entry for issuing the stock.
More Than One Security Issuedfor a Single Price
18-34
GENERAL JOURNAL
Page 1
Date Description PR Debit Credit
Cash 450,000 Common Stock, par $10 50,000 Preferred Stock, par $5 15,000 Additional paid-in capital, Common Stock 197,500 Additional paid-in capital Preferred Stock 187,500
To record issue of stock for cash
More Than One Security Issuedfor a Single Price
18-35
Share Issue Costs
Share issue costs reduce net proceedsfrom selling shares, resulting in a lower
amount of additional paid-in capital.
Registration fees Underwriter commissions Printing and clerical costs Legal and accounting fees Promotional costs
18-36
Share Purchase Contracts
An agreement between a corporation anda subscriber whereby shares are sold in exchange for a promissory note.
An agreement between a corporation anda subscriber whereby shares are sold in exchange for a promissory note.
Dow Industrial sold 100,000 shares of its$1 par value stock for $10 using a share
purchase contract. Forty percent of the saleprice was collected at sale and sixty
percent will be received in six months.
Prepare the journal entry for this transaction.
Dow Industrial sold 100,000 shares of its$1 par value stock for $10 using a share
purchase contract. Forty percent of the saleprice was collected at sale and sixty
percent will be received in six months.
Prepare the journal entry for this transaction.
18-37
Share Purchase Contracts
The receivable is not an asset.It is reported as reduction in paid-in capital.
The receivable is not an asset.It is reported as reduction in paid-in capital.
18-39
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.
18-40
I can account forthe reacquired sharesby retiring them or by
holding them astreasury shares.
Share Buybacks
18-41
Learning Objectives
Describe what occurs when shares are retired and how retirement is recorded.
18-42
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.
18-43
5,000 shares of $2 par value stock that were issued for $20 per share are reacquired for $17 per share.
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.
Accounting for Retired Shares
18-44
Price paid is more than issue price.
5,000 shares of $2 par value stock that were issued for $20 per share are reacquired for $25 per share.
5,000 shares of $2 par value stock that were issued for $20 per share are reacquired for $25 per share.
Accounting for Retired Shares
Reduce Retained Earnings if the Paid-in Capital – Share Repurchase
account balance is insufficient.
18-45
Learning Objectives
Distinguish between accounting for retired shares and for treasury shares.
18-46
Treasury Stock
Usually does not have: Voting rights. Dividend rights. Preemptive rights. Liquidation rights.
Reduces both assets andshareholders’ equity.
18-47
Acquisition of Treasury Stock Recorded at cost to acquire.
Resale of Treasury Stock Treasury Stock credited for cost. Difference between cost and
issuance price is (generally)recorded in paid-in capital –share repurchase.
Acquisition of Treasury Stock Recorded at cost to acquire.
Resale of Treasury Stock Treasury Stock credited for cost. Difference between cost and
issuance price is (generally)recorded in paid-in capital –share repurchase.
Accounting for Treasury Stock
18-48
On 5/1/05, Photos-in-a-Second reacquired 3,000 shares of its common stock at $55 per share. On 12/3/06, 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 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.
On 5/1/05, Photos-in-a-Second reacquired 3,000 shares of its common stock at $55 per share. On 12/3/06, 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 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.
Accounting for Treasury Stock
18-49
On 5/1/05, Photos-in-a-Second reacquired 3,000 shares of its common stock at $55 per share. On 12/3/06, 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 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.
On 5/1/05, Photos-in-a-Second reacquired 3,000 shares of its common stock at $55 per share. On 12/3/06, 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 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.
Solution
Accounting for Treasury Stock
18-51
Reporting Treasury Stock
Reported in Shareholders’ Equity.
Unallocated reductionof total Shareholders’Equity.
Reported in Shareholders’ Equity.
Unallocated reductionof total Shareholders’Equity.
18-53
Retained Earnings
Represents the undistributed earnings of the company since its inception.
Represents the undistributed earnings of the company since its inception.
Balance January 1, 2006 $ 500,000 Net income 25,000 Cash dividends (10,000) Balance December 31, 2006 515,000$
18-54
Retained Earnings
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 earningsmust be disclosed in the notes to the financial statements.
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 earningsmust be disclosed in the notes to the financial statements.
18-56
Learning Objectives
Explain the basis of corporate dividends, including the similarities and differences between cash and property dividends.
18-57
Cash Dividends
Dividends must bedeclared by the board
of directors beforethey can be paid.
When a dividend isdeclared, a liability
is created.
A corporation is notlegally required to
pay dividends.
Cash dividendsrequire sufficient cashand retained earningsto cover the dividend.
18-58
Dividend Dates
Declaration date Board of directors declares
the dividend. Record a liability.
GENERAL JOURNAL Page 12
Date DescriptionPost. Ref. Debit Credit
Retained Earnings XXX
Dividends Payable XXX
18-59
Dividend Dates
Ex-dividend date The first day the shares trade without the
right to receive the declared dividend.(No entry)
July
X
18-60
Dividend Dates
Date of record Stockholders holding shares on this date
will receive the dividend. (No entry)
July
X X
July
18-61
Dividend Dates
Date of payment Record the payment of the
dividend to stockholders.
GENERAL JOURNAL Page 12
Date DescriptionPost. Ref. Debit Credit
Dividends Payable XXX
Cash XXX
18-62
Property Dividends
Distributions of non-cash assets.
Record at fair value of non-cash asset.
Recognize gain or loss for difference between book value and fair value.
Distributions of non-cash assets.
Record at fair value of non-cash asset.
Recognize gain or loss for difference between book value and fair value.
18-64
Stock Dividends
All shareholders receive the same
percentage increase in shares.
All shareholders receive the same
percentage increase in shares.
No change in total shareholders’ equity.No change in total
shareholders’ equity.
Distribution of additional shares of stock to shareholders.
18-65
Stock Dividends
Reasons for stock dividends:
To preserve cash.
To decrease market priceof stock.
To reduce existing balance in retained earnings.
18-66
Record at currentmarket value
of stock.
Record at currentmarket value
of stock.
Stock dividend < 25%Stock dividend < 25%
Stock Dividends
Stock dividend 25%Stock dividend 25%
Record at par or stated value
of stock.
Record at par or stated value
of stock.
Small Large
>
18-67
Stock Dividends
CarCo declares and distributes a 20% stock dividend on 5 million common
shares. Par value is $1 and market value is $20. Prepare the required journal entry.
GENERAL JOURNAL Page 21
Date DescriptionPost. Ref. Debit Credit
18-68
Stock Dividends
GENERAL JOURNAL Page 21
Date DescriptionPost. Ref. Debit Credit
Retained Earnings 20,000,000
Common Stock 1,000,000
Paid-in Capital in
Excess of Par 19,000,000
CarCo declares and distributes a 20% stock dividend on 5 million common
shares. Par value is $1 and market value is $20. Prepare the required journal entry.
18-69
Stock Splits
Decrease par value of stock.
Increase number of outstanding shares.
No change in total stockholders’ equity.
Does not require a journal entry.
Ice Cream Parlor
Banana Splits On Sale Now
18-70
Accounting for Stock Splits
A corporation had 5,000 shares of$1 par value common stock outstanding
before a 2–for–1 stock split.
A corporation had 5,000 shares of$1 par value common stock outstanding
before a 2–for–1 stock split.
Before Split
After Split
Common Stock Shares 5,000
Par Value per Share 1.00$
Total Par Value 5,000$
18-71
Accounting for Stock Splits
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$
A corporation had 5,000 shares of$1 par value common stock outstanding
before a 2–for–1 stock split.
A corporation had 5,000 shares of$1 par value common stock outstanding
before a 2–for–1 stock split.
18-72Stock Splits Effected in theForm 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.
18-73
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 and the company will
capitalize retained earnings.
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 $14 per share. The per share par value of the shares is not to be changed and the company will
capitalize retained earnings.
Stock Splits Effected in theForm of Large Stock Dividends
18-75
Quasi Reorganizations
Purpose
To allow a company undergoing financial difficulty, but with favorable future
prospects, to get a fresh start by writing down inflated assets and eliminating an
accumulated balance in retained earnings.
Purpose
To allow a company undergoing financial difficulty, but with favorable future
prospects, to get a fresh start by writing down inflated assets and eliminating an
accumulated balance in retained earnings.
18-76
Procedures
The firm’s assets and liabilities are revalued to reflect market values, with corresponding debits and credits to retained earnings.
The debit balance in retained earnings is eliminated first against additional paid in capital, and then, if necessary, against common stock.
Retained earnings is dated to indicate when the new accumulation of earnings began.
Procedures
The firm’s assets and liabilities are revalued to reflect market values, with corresponding debits and credits to retained earnings.
The debit balance in retained earnings is eliminated first against additional paid in capital, and then, if necessary, against common stock.
Retained earnings is dated to indicate when the new accumulation of earnings began.
Quasi Reorganizations
18-77
Emerson-Walsch Corporation has incurredlosses for several years. The board
of directors voted to implement a quasi reorganization, subject
to shareholder approval.
The balance sheet prior to restatement, in millions, follows :
Emerson-Walsch Corporation has incurredlosses for several years. The board
of directors voted to implement a quasi reorganization, subject
to shareholder approval.
The balance sheet prior to restatement, in millions, follows :
Quasi Reorganizations
18-78
(millions)Cash 75$ Receivables 200 Inventory 375 Property, plant, and equipment (net) 400 Total assets 1,050$
Liabilities 400$ Common stock (800 million shares @$1) 800 Additional paid-in capital 150 Retained earnings (deficit) (300) Total liabilities and equity 1,050$
Let’s prepare the journal entriesnecessary for the quasi reorganization.
Let’s prepare the journal entriesnecessary for the quasi reorganization.
Quasi Reorganizations
Fair value of the inventory is $300,000,000 and fair valueof the property, plant, and equipment is $225,000,000.
18-79
GENERAL JOURNAL Page 43
Date DescriptionPost. Ref. Debit Credit
Retained Earnings 250
Inventory 75
Property, plant, & equipment 175
To revalue assets.
Quasi Reorganizations
18-80
GENERAL JOURNAL Page 43
Date DescriptionPost. Ref. Debit Credit
Additional paid-in capital 150
Common stock 400
Retained earnings 550
To eliminate the deficit in retained earnings
Now, let’s prepare the balance sheetimmediately after restatement.
Now, let’s prepare the balance sheetimmediately after restatement.
Quasi Reorganizations
$300 + $250
18-81
Cash 75$ Receivables 200 Inventory 300 Property, plant, and equipment (net) 225 Total assets 800$
Liabilities 400$ Common stock (800 million shares @$.50) 400 Additional paid-in capital 0Retained earnings 0 Total liabilities and equity 800$
Quasi Reorganizations