Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 1999

Sources of Capital: Owners’ Equity

© The McGraw-Hill Companies, Inc., 1999

9Part One: Financial Accounting

Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 1999

Forms of Business Organizations Slide 9-1

Owned by an individual

No incorporation fees

No special reports

Profits taxed at proprietor’s personal tax rate

Personally responsible for the entity’s debts

Borrow money as an individual

Owned by an individual

No incorporation fees

No special reports

Profits taxed at proprietor’s personal tax rate

Personally responsible for the entity’s debts

Borrow money as an individual

Sole Proprietorship

Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 1999

Forms of Business Organizations Slide 9-2

Owned by two or more persons

Each partner is personally liable for all debts incurred by firm

Each partner is responsible for

business actions of other partners

Taxed as individuals

Owned by two or more persons

Each partner is personally liable for all debts incurred by firm

Each partner is responsible for

business actions of other partners

Taxed as individuals

Partnership

Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 1999

Forms of Business Organizations Slide 9-3

Legal entity with essentially perpetual existence

Granted a charter to operate

Taxed as an entity

Limited liability to owners

Ownership of an individual is easily added or liquidated

Legal entity with essentially perpetual existence

Granted a charter to operate

Taxed as an entity

Limited liability to owners

Ownership of an individual is easily added or liquidated

Corporation

Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 1999

There may be significant legal and other fees involved in formation.

The corporation’s activities are limited to those specifically granted in its charter.

It is subject to numerous regulations and requirements.

It must secure permission from each state in which it wishes to operate.

Its income is subject to double taxation.

There may be significant legal and other fees involved in formation.

The corporation’s activities are limited to those specifically granted in its charter.

It is subject to numerous regulations and requirements.

It must secure permission from each state in which it wishes to operate.

Its income is subject to double taxation.

Disadvantages of the Corporation Form Slide 9-4

Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 1999

Salary $60,000 $20,000 $40,000

Interest on capital 8,000 2,400 5,600

Remainder 12,000 6,000 6,000

Total $80,000 $28,400 $51,600

Partnership Equity Slide 9-5

The partnership agreement of Jackson and Curtin provided that Jackson would receive a salary of $20,000 and Curtin a salary of

$40,000; that each would receive 8 percent interest on their invested capital; and they they would share any remainder equally.

The partnership’s net income for the year is $80,000.

The partnership agreement of Jackson and Curtin provided that Jackson would receive a salary of $20,000 and Curtin a salary of

$40,000; that each would receive 8 percent interest on their invested capital; and they they would share any remainder equally.

The partnership’s net income for the year is $80,000.

Total Jackson Curtin

Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 1999

Salary $60,000 $20,000 $40,000

Interest on capital 8,000 2,400 5,600

Remainder 12,000 6,000 6,000

Total $80,000 $28,400 $51,600

Partnership Equity Slide 9-6

If the partnership agreement is silent concerning the remainder, then it is

divided equally.

If the partnership agreement is silent concerning the remainder, then it is

divided equally.

Total Jackson Curtin

Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 1999

Recording a Common Stock Issue Slide 9-7

Kuick Corporation is authorized to issue 200,000 shares of $1 par value common stock. Of these,

100,000 shares were issued at $7 per share.

Kuick Corporation is authorized to issue 200,000 shares of $1 par value common stock. Of these,

100,000 shares were issued at $7 per share.

Cash 700,000

Common Stock at Par 100,000

Additional Paid-In Capital 600,000100,000 x $1100,000 x $1

Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 1999

Cash Dividend Slide 9-8

Kuick Corporation declares a $6,000 dividend on December 15 to be paid on January 15 to holders

of record as of January 1.

Kuick Corporation declares a $6,000 dividend on December 15 to be paid on January 15 to holders

of record as of January 1.

December 15Retained Earnings 6,000

Dividends Payable 6,000

January 1 (no entry)

January 15Dividends Payable 6,000

Cash 6,000

Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 1999

Stock Dividend Slide 9-9

Kuick Corporation declares and issues a 5 percent stock dividend to the holders of its 100,000

outstanding shares (par value of $1) when the market price of a share is $10.50.

Kuick Corporation declares and issues a 5 percent stock dividend to the holders of its 100,000

outstanding shares (par value of $1) when the market price of a share is $10.50.

Retained Earnings 52,500Common Stock at Par 5,000Additional Paid-In Capital 47,500

5,000 x $10.50

5,000 x $10.50 5,000 x

$1

5,000 x $1

Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 1999

Common stock, $25 per share $ 77.6 $ 77.5

Capital in excess of par 72.0 60.2

Retained earnings 3.409.4 3.033.9

Treasury stock, at cost (1,653.1) (1,105.0)

Total stockholders’ equity $1,905.9 $2,075.6

Balance Sheet Presentation Slide 9-10

PRESTON COMPANY AND SUBSIDIARIESConsolidated Balance Sheet

At December 31(millions)

1998 1997

Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 1999

Basic Earnings Per Share Slide 9-11

Basic earnings per share is a measurement of the corporation’s per share performance

over a period of time.

Basic earnings per share is a measurement of the corporation’s per share performance

over a period of time.

Earnings per share =Net income

Number of shares of common stock outstanding

Earnings per share =$7,000,000

1,000,000 shares= $7

Assume Nugent Corporation had net income of $7 million and 1 million shares of

common stock outstanding.

Assume Nugent Corporation had net income of $7 million and 1 million shares of

common stock outstanding.

Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 1999

= $6.20

Now, assume that Nugent Corporation also has 100,000 shares of $8 convertible

preferred stock.

Now, assume that Nugent Corporation also has 100,000 shares of $8 convertible

preferred stock.

Basic Earnings Per Share Slide 9-12

Earnings per share =Net income - Preferred dividends

Number of shares of common stock outstanding

Earnings per share =$7,000,000 - $800,000

1,000,000 shares

Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 1999

= $5.83

For diluted earnings per share, we assume that the 100,000 convertible preferred shares are

exchanged for 200,000 shares of common stock.

For diluted earnings per share, we assume that the 100,000 convertible preferred shares are

exchanged for 200,000 shares of common stock.

Earnings Per Share Slide 9-13

Earnings per share =Net income - Preferred dividends

Number of shares of common stock outstanding

Earnings per share =$7,000,000

1,200,000 shares

Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 1999

= $5.83

For diluted earnings per share, we assume that the 100,000 convertible preferred shares are

exchanged for 200,000 shares of common stock.

For diluted earnings per share, we assume that the 100,000 convertible preferred shares are

exchanged for 200,000 shares of common stock.

Slide 9-14

Earnings per share =Net income - Preferred dividends

Number of shares of common stock outstanding

Earnings per share =$7,000,000

1,200,000 shares

Note that all the preferred stock is assumed converted, sothere would be no dividends.

Note that all the preferred stock is assumed converted, sothere would be no dividends.1,000,000 shares of common stock

plus the 200,000 shares assumedfrom converting preferred stock

1,000,000 shares of common stockplus the 200,000 shares assumedfrom converting preferred stock

Earnings Per Share

Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 1999

1,000,000 x 12/12 = 1,000,000

500,000 x 6/12 = 250,000

Denominator amount 1,250,000

Slide 9-15 Weighted-Average Number of Shares

Optel Corporation had 1 million shares of common stock outstanding on January 1. On July

1 it issued an additional 500,000 shares. How many weighted-average shares would be used for

calculating earnings per share?

Optel Corporation had 1 million shares of common stock outstanding on January 1. On July

1 it issued an additional 500,000 shares. How many weighted-average shares would be used for

calculating earnings per share?

Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 1999

Slide 9-16 Zero-Coupon Bonds

Bonds with a total par of $100,000 and carrying zero interest are issued when the current yield is 14 percent. How much should the investor pay

for each $1,000 bond?

Bonds with a total par of $100,000 and carrying zero interest are issued when the current yield is 14 percent. How much should the investor pay

for each $1,000 bond?

$1,000 x .519 = $519 per $1,000 bond

No cash is paid by the borrower until these bonds mature.

No cash is paid by the borrower until these bonds mature.

Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 1999

Slide 9-17 Debt With Warrants

Some corporations issue warrants in conjunction with the issuance of bonds,

putting an exercise price on the warrants of about 15 to 20 percent above the current

market price of the common stock.

Some corporations issue warrants in conjunction with the issuance of bonds,

putting an exercise price on the warrants of about 15 to 20 percent above the current

market price of the common stock.

If detachable, the warrants can be removed from the debt and used to purchase the issuer’s stock or sold

to a third party.

If detachable, the warrants can be removed from the debt and used to purchase the issuer’s stock or sold

to a third party.

Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 1999

Slide 9-18 Debt With Warrants

If nondetachable, the debt is accounted for as if it were a convertible debt

security--no recognition is given to the equity

character of the debt.

If nondetachable, the debt is accounted for as if it were a convertible debt

security--no recognition is given to the equity

character of the debt.

Some corporations issue warrants in conjunction with the issuance of bonds,

putting an exercise price on the warrants of about 15 to 20 percent above the current

market price of the common stock.

Some corporations issue warrants in conjunction with the issuance of bonds,

putting an exercise price on the warrants of about 15 to 20 percent above the current

market price of the common stock.

Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 1999

Slide 9-19 Redeemable Preferred Stock

Redeemable preferred stock not only pays dividends, it may also be redeemed by the

investor on or after a certain date.

Redeemable preferred stock not only pays dividends, it may also be redeemed by the

investor on or after a certain date.

The SEC requires that redeemable preferred stock be listed as a separate item on the balance sheet at it’s redemption price. This item must be

listed between the liability and owners’ equity section and not included in the total of either

liabilities or owner’s equity.

The SEC requires that redeemable preferred stock be listed as a separate item on the balance sheet at it’s redemption price. This item must be

listed between the liability and owners’ equity section and not included in the total of either

liabilities or owner’s equity.

Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 1999

Slide 9-20 Redeemable Preferred Stock

Redeemable preferred stock $ 8,000,000Stockholders’ equity:

Common stock @ $1 par 20,000,000Additional paid-in capital 75,000,000

Total paid-in capital 95,000,000Retained earnings 60,000,000 Total stockholders’ equity $155,000,000

Redeemable preferred stock $ 8,000,000Stockholders’ equity:

Common stock @ $1 par 20,000,000Additional paid-in capital 75,000,000

Total paid-in capital 95,000,000Retained earnings 60,000,000 Total stockholders’ equity $155,000,000

The $8 million for redeemable preferredstock is not included.

The $8 million for redeemable preferredstock is not included.

Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 1999

Chapter 9

The End