stockholders’ equity

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

1


22

Stockholders’ EquityChapter 10


3

Explain the features of a corporation


4

ADVANTAGES DISADVANTAGES

• Can raise more capital than a proprietorship or partnership can

• Continuous life• Transferability of

ownership• Limited liability

• Separation of ownership and management

• Corporate taxation• Government regulation

Corporate Characteristics


5

Organizing a Corporation

•Corporate organizers (incorporators) obtain a charter from the state▫Charter includes authorization to issue

shares of stock•Incorporators:

▫Pay fees▫Sign the charter▫File documents with the state▫Agree to set of bylaws


6

StockholdersStockholders

Chairperson of the Board (CEO)Chairperson of the Board (CEO)

Board of DirectorsBoard of Directors

President (Chief Operating Officer)President (Chief Operating Officer)

Vice-Presidents

Vice-Presidents

Chief Financial Officer

Chief Financial Officer

SecretarySecretary

ControllerController TreasurerTreasurer


7

Stockholder Rights


8

Stockholders’ Equity


9

COMMON PREFERRED

• Basic form of stock• Has four basic rights• Shareholders benefit most

if corporation succeeds▫ Take more risk

• Has advantages over common▫ Receive dividends first▫ Receive assets first in

liquidation• Shareholders earn a fixed

dividend• Very few corporations

issue

Classes of Stock


10

Comparison of Issuing Stock and Debt

Common stock

Preferred stock

Long-term debt

Obligation to repay principal

No No Yes

Dividends/interest Dividends are not tax-deductible

Dividends are not tax-deductible

Interest expense is tax-deductible

Obligation to pay dividends/interest

Only after declaration

Only after declaration

At fixed rates and date


11

Par Value

•Arbitrary amount assigned to share of stock

•Usually set low to avoid legal issues▫Most states do not allow companies to

issue stock below par•No-par stock

▫May have a stated value


12

Account for the issuance of stock


13

Issuing Stock at Par

JOURNAL

Date Accounts and explanation Debit Credit

Cash 50,000

Common Stock 50,000

Issued stock at par value


14

Issuing Stock above Par

JOURNAL

Date

Accounts and explanation Debit Credit

Cash 300,000

Common Stock 50,000

Paid-in Capital in Excess of Par - Common

250,000

Issued stock above par value


15

A company neither earns a profit nor incurs a loss

when it sells it stock to, or buys stock from, its own

shareholders.


16

Issuing No-Par Stock

JOURNAL

Date


Cash 300,000

Common Stock 300,000

Issued no-par stock


17

Stock Issued for Non-Cash Assets•Asset received is recorded at current

market value

JOURNAL

Date


Equipment 100,000

Common stock 20,000

Paid-in Capital in Excess of Par - Common

80,000

Issued stock in exchange for equipment


18

Stock Issued for Services

•Expense recognized for fair value of services rendered

JOURNAL

Date


Legal Expense 25,000

Common Stock 2,500

Paid-in Capital in Excess of Par–Common

22,500

Issued stock in exchange for legal services


19

Preferred Stock

•Follows same pattern as accounting for common stock

•May have separate accounts for paid-in capital in excess of par for preferred and common

•Can be issued with conversion feature▫Allows preferred shareholders to exchange

preferred shares for common


20

Distinct Number of Shares


21

Show how treasury stock affects a company


22

Treasury Stock

•Issued shares reacquired by the company•Reasons:

▫Make shares available for employee stock purchase plans

▫Plan to “buy low” and “sell high”▫Avoid takeover▫Increase earnings per share▫Use in share repurchase program


23

Recording Treasury Stock•Recorded at cost

▫Not par value•Classified as a contra-stockholders’ equity

account▫Debit balance

JOURNAL

Date


Treasury Stock 95,000

Cash 95,000

Purchased treasury stock.


24

Retiring Stock

•Cancel stock certificates•Cannot be reissued

JOURNAL

Date


Common Stock

Additional Paid-in Capital

Retained Earnings

Treasury Stock


25

Resale of Treasury Shares

JOURNAL

Date


Cash 100,000

Treasury stock 95,000

Additional Paid-in Capital 5,000

Sold treasury stock.


26

Exercise 10-24AJOURNAL


Jan 21

Cash 23,400

Common Stock 2,250

Paid-in Capital in Excess of Par—Common

21,150

Issued shares.

Jun 23


Cash 7,500

Purchased treasury stock.

Jul 12 Cash 8,800


Additional Paid-in Capital 2,800

Sold treasury stock.


27

Exercise 10-24A

Effect on Stockholders’ Equity

1-21 Common stock issued $23,400

6-23 Purchase of treasury stock

(7,500)

7-15 Sale of treasury stock 8,800

Total change $24,700


28

Account for retained earnings, dividends and splits


29

Retained Earnings


30

Retained Earnings Balance

Credit balance

Lifetime earnings

Lifetime losses & dividends

>

Debit balance

Lifetime earnings

Lifetime losses & dividends

<


31

Cash Dividends

•Company must have both:▫Enough Retained earnings to declare the

dividend▫Enough Cash to pay the dividend

•Board of directors has authority to declare a dividend▫Company not obligated to pay dividend

until declared


32

Dividend Dates

JOURNAL


Retained Earnings

Dividends Payable

1. Declaration date1. Declaration date

2. Date of record2. Date of record

3. Payment date3. Payment date

JOURNAL


Dividends Payable

Cash

No entry


33

Analyzing Retained Earnings

Retained Earnings

Beginning balance

Ending balance

Net Income

Dividends


34

Dividends on Preferred Stock

•Paid dividends before common stockholders

•Stated as a percent of par value or a dollar amount per share

•May be cumulative▫Passed dividends are owed to preferred

shareholders In arrears

▫Almost debt


35

Exercise 10-28APreferred dividend = $1.00 x 6% x 90,000 shares

$5,400$5,400

Preferred Common

2012 - $90,000

Dividends in arrears (2 years x 5,400) $10,800

Current year 5,400

16,200

Remainder to common $73,800

2013 - $270,000

Preferred – current year 5,400

Remainder to common $264,600


36

Stock Dividends

•Proportional distribution of stock to shareholders

•Increase stock account and decrease Retained Earnings▫Total equity is unchanged

•Reasons stock dividends are distributed▫Continue dividends, but conserve cash▫Reduce market price of shares


37

SMALL LARGE

• 25% or less of outstanding shares

• Recorded at market value

• Greater than 25% of outstanding shares

• Recorded at par value

Size of Stock Dividends


38

Stock Splits

•Increase in shares with a proportionate reduction in par value

•Decreases market price of shares•No accounts affected


39

Effect on Total

Transaction Assets = Liabilities +


Issuance of stock Increase No effect Increase

Purchase of treasury stock Decrease No effect Decrease

Sale of treasury stock Increase No effect Increase

Declaration of cash dividend No effect Increase Decrease

Payment of cash dividend Decrease Decrease No effect

Stock dividend No effect No effect No effect

Stock split No effect No effect No effect


40

Use stock values in decision making


41

Stock Values


42

DuPont Analysis

Return on assets

Net profit

margin

Net profit

margin

Asset turnover

Asset turnover

Leverage ratio

Return on equity

Leverage ratio

Leverage ratio

Return on

equity

Return on

equity

Net incom

e

Net incom

e

Net salesNet

sales

Net salesNet

sales

Average total

assets

Average total

assets

Average total

assets

Average total

assetsAverage common equity

Average common equity

Net incom

e

Net incom

eAverage common equity

Average common equity


43

Report equity transactions in the financial statements


44

Equity Transactions on the Cash Flow Statement

Transaction Shown in the Financing Activity Section as a:

Issue stock for cash Inflow

Purchase treasury stock Outflow

Sell treasury stock Inflow

Pay dividends Outflow


45

Stockholders’ Equity on the Balance Sheet


Preferred stock, 7%, $100 par, 5,000

shares authorized and issued $500,000

Common stock, $1 par, 100,000 shares

authorized, 75,000 shares issued 75,000

Additional paid-in capital 2,500,000

Retained earnings 1,300,000

Less treasury stock, common (50,000)

Total stockholders’ equity $4,325,000


46


47

stockholders’ equity

Business

prentice hall

pearson education

common stock

issued stock

preferred stock

issuance of stock

recording treasury stock

stockbelow par nopar