Stockholders’ Equity

Chapter 10

Explain the advantages

and disadvantages

of a corporation.

What is the Best Way toOrganize a Business?

Proprietorship

Partnership

Corporation

Advantages and Disadvantagesof a Corporation

1. Separation of ownership2. Corporate taxation3. Government regulation

Disadvantages

1. Can raise more capital than a proprietorship or partnership can2. Continuous life is possible3. Ease of transferring ownership4. Limited liability of stockholders

Advantages

Stockholders’ Equity

Paid-in capital(contributed capital)

Retained earnings

Owners’ equity in a corporationhas two main components:

Capital Stock

Corporate ownership is evidencedby a stock certificate which may

be for any number of shares.

Capital Stock

Common Stock

The most basic formof capital stockissued by every

corporation.

Preferred Stock

A class of stockthat has several

preferences overcommon stock.

Measure the effect of issuing

stock on a company’s

financial position.

Common Stock at Par

Suppose IHOP’s common stockcarries a par value of $10 per share.

The company issues 6,200,000

shares of common stock at par.

What is the entry?

Common Stock at Par

January 8Cash (6,200,000 × $10) 62,000,000

Common Stock 62,000,000To issue common stock

Common Stock Above Par

IHOP’s common stock has apar value of $0.01 per share.

The company issues 6,200,000 sharesof common stock at $10 per share.

What is the entry?

Common Stock Above Par

July 23Cash (6,200,000 × $10) 62,000,000

Common Stock (6,200,000 × $0.01) 62,000Paid-in Capital in Excess of Par – Common (6,200,000 × $9.99) 61,938,000

To issue common stock

Common Stock Above Par

Common Stock, $.01 par; 40 million shares authorized, 6.2 million shares issued $ 62,000Paid-in capital in excess of par 61,938,000Total paid-in capital $ 62,000,000Retained earnings 194,000,000Total stockholders’ equity $256,000,000

Stockholders’ Equity

No-Par Common Stock

When a company issues no-par stock, it debitsthe asset received and credits the stock account.

August 14Cash (3,000 × $20) 60,000

Common Stock 60,000To issue no-par common stock

Preferred Stock

Accounting for preferred stock follows thepattern illustrated for common stock.

Stockholders’ equity on the balance sheetlists preferred stock, common stock,and retained earnings – in that order.

Describe how treasury stock

transactions affect a company.

Treasury Stock Transactions

Treasury stock are shares that a companyhas issued and later reacquired.

Stock purchase plan distribution

Increase net assets (i.e. SE)

Avoidance of a takeover

Reasons for purchasing their own stock:

IHOP Corp. Purchaseof Treasury Stock

November 12, 2000Treasury Stock 5,170

Cash 5,170Purchased treasury stock

November 12, 2000Treasury Stock 5,170

Cash 5,170Purchased treasury stock

During 2000, IHOP paid $5,170 to purchase288 shares of its common stock as treasury stock.

During 2000, IHOP paid $5,170 to purchase288 shares of its common stock as treasury stock.

($000)

IHOP Corp. After Purchaseof Treasury Stock

Common Stock $ 203Paid-in capital in excess of par 69,655Retained earnings 193,632Less: Treasury stock (288 shares at cost) – 5,170Total equity $258,320

Stockholder’s Equity at December 31, 2000(with treasury stock purchased – $000)

Sale of Treasury Stock

Assume that on July 22, 2002, the sharesof treasury stock are sold for $5,300.

Assume that on July 22, 2002, the sharesof treasury stock are sold for $5,300.

Cash 5,300Treasury Stock 5,170PIC from T Stock Transactions 130

Sold treasury stock

Cash 5,300Treasury Stock 5,170PIC from T Stock Transactions 130

Sold treasury stock

Account for dividends and

measure their impact

on a company.

Dividends

A dividend is a corporation’s returnto its stockholders of some of the

benefits of earnings.

Dividend Dates

Declaration date

Date of record Payment date

Three relevant dates for dividends are:

Preferred Stock Dividends

When a company has issued bothpreferred and common stock,

the preferred stockholdersreceive their dividends first.

When a company has issued bothpreferred and common stock,

the preferred stockholdersreceive their dividends first.

Pinecraft Industries, Inc., has bothcommon stock and 90,000 shares

of preferred stock outstanding.

Pinecraft Industries, Inc., has bothcommon stock and 90,000 shares

of preferred stock outstanding.

Preferred Stock Dividends

Preferred dividend (90,000 × $1.75 per share) $157,500 Common dividend ($1,500,000 – $157,500) 1,342,500 Total dividend $1,500,000

Preferred dividends are paid at the annualrate of $1.75 per share.

Assume that in 2004, the company declaresan annual dividend of $1,500,000.

Expressing the Dividend Rateon Preferred Stock

Dollar amount per share

Percentage rate (% of Par)

Preferred Stock Dividends

The preferred stock of Pinecraft is CUMULATIVE

Retained Earnings 500,000Divs Payable, Pfd ($157,500 × 2 years) 315,000Divs Payable, CS ($500,000 – $315,000) 185,000

To declare a cash dividend

Suppose the company passed/ skipped/ did NOT pay the 2004preferred dividend of $157,500. They didn’t pay ANY div

In 2005, the company declares a $500,000 dividend.

Why Issue a Stock Dividend?

To continue dividends but conserve cash

To reduce the per-share market price of its stock

Stock Dividend

IHOP declared a 10% stock dividend in 2001.

The stock is trading for $15 per share.

How would this stock dividend be recorded?

Assume IHOP had 20,000,000 sharesof common stock outstanding.

Stock Dividend

Retained Earnings (20,000,000 × 10% × $15) 30,000,000CS (20,000,000 × 10% × $0.01) 20,000Paid-in Capital

29,980,000Distributed a 10% stock dividend

Stock Splits

A stock split is an increase in the number ofauthorized, issued, and outstanding shares

of stock, coupled with a proportionatereduction in the stock’s par value.

A stock split decreases the market price of stock.

Stock Splits

The market price of a share of Quaker Oatshas been approximately $25.

This 2-for-1 split means that the companywould have twice as many shares outstanding

after the split.

Assume that the company wantsto decrease it to $12.50.

Use different stock values

in decision making.

Stock Values

Market value

Redemption value

Liquidation value(amount pfd SH’s will get paid if company liquidates)

Book value

Book Value

Book value of preferred stock= Redemption value + Dividends in arrears

Book value of common stock= Total stockholders’ equity – Preferred equity

Book Value

Preferred stock, 6%, $100 par, 5,000 shares authorized, 400 shares issued, redemption value $130 per share $ 40,000Additional paid-in capital in excess of par – preferred 4,000Common stock, $10 par, 20,000 shares authorized, 5,500 shares issued 55,000Additional paid-in capital in excess of par – common 72,000Retained earnings 85,000Treasury stock – common, 500 shares at cost – 15,000Total stockholders’ equity $241,000

Stockholders’ EquityAssume that a company’s balance sheet reports the following:

Book Value

Suppose that four years’ (including the current year)cumulative preferred dividends are in arrears.

The book-value-per-share computationsfor this company are as follows:

Book Value

Preferred equity:Redemption value (400 shares × 130) $ 52,000Cumulative dividends ($40,000 × $0.06 × 4 years) 9,600Preferred equity $ 61,600

Common equity:Total stockholders’ equity $241,000Less preferred equity – 61,600Common equity $179,400

Book value per share: $179,400 ÷ 5,000 shares* $ 35.88*5,500 shares issued minus 500 treasury shares

Evaluate a company’s return

on assets and return on

stockholders’ equity.

Return on Assets

Rate of return on total assets= (Net income + Interest expense)

÷ Average total assets

It is a measure of a company’s ability togenerate profits from the use of its assets.

Return on Equity

Rate of return on common stockholders’ equity= (Net income – Preferred dividends)

÷ Average common stockholders’ equity

It is a measure of the income earned from thecommon stockholders’ investment in the company.

End of Chapter 10