The Statement of The Statement of Stockholders’ EquityStockholders’ Equity

Module 5Module 5

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Statement of Shareholders’ Statement of Shareholders’ EquityEquity

Documents changes in balance sheet equity Documents changes in balance sheet equity accounts from one accounting period to the accounts from one accounting period to the nextnext

Provides an important link between the Provides an important link between the balance sheet and the income statementbalance sheet and the income statement

Company may report info in note or Company may report info in note or supplementary schedule rather than formal supplementary schedule rather than formal statement if desired….(many do!)statement if desired….(many do!)

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Statement of S/EStatement of S/E

In a nutshell, it simply explains how In a nutshell, it simply explains how each account got from the balance at each account got from the balance at the beginning of the period to the the beginning of the period to the balance at the end of the period and balance at the end of the period and describes “events” that caused the describes “events” that caused the balances to changebalances to change

Federal Express Statement of Changes Federal Express Statement of Changes in Stockholders' Equityin Stockholders' Equity

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Retained EarningsRetained Earnings

Changes in R/E account are primarily result Changes in R/E account are primarily result of net income/loss and dividendsof net income/loss and dividends

Balance can also be affected by prior period Balance can also be affected by prior period adjustments and some changes in adjustments and some changes in accounting principlesaccounting principles

Changes in R/E are watched by analysts Changes in R/E are watched by analysts and the details on what caused the changes and the details on what caused the changes are documented in the Statement of are documented in the Statement of Stockholders’ EquityStockholders’ Equity

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Ownership of a CorporationOwnership of a Corporation

Owners of common stock generally Owners of common stock generally receive the following rights:receive the following rights:– Voting (in person or by Voting (in person or by proxyproxy).).– Distributions of profits Distributions of profits (in the form of(in the form of Dividends). Dividends).

– Distributions of assets in a liquidation.Distributions of assets in a liquidation.– Offers to purchase shares of a new stock Offers to purchase shares of a new stock

issue (issue (pro rata basispro rata basis).).

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AuthorizedAuthorized, Issued, and , Issued, and Outstanding Capital StockOutstanding Capital Stock

The maximum number of shares of capital stock that can be sold to the public is called the authorized number of shares.

AuthorizedShares

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Authorized, Authorized, IssuedIssued, and , and Outstanding Capital StockOutstanding Capital Stock

Authorized Shares

Issued shares have been

sold.

Unissued shares have

never been sold.

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Authorized, Issued, and Authorized, Issued, and Outstanding Capital StockOutstanding Capital Stock

AuthorizedShares

UnissuedShares

OutstandingShares

owned by stockholders.

IssuedShares

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Authorized, Issued, and Authorized, Issued, and Outstanding Capital StockOutstanding Capital Stock

AuthorizedShares

UnissuedShares

TreasuryShares

OutstandingShares

owned by stockholders.

IssuedShares

reacquired by the corporation.

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Sale and Issuance of Capital Sale and Issuance of Capital StockStock

An An initial public offering (IPO) initial public offering (IPO) is the very is the very first time a corporation sells stock to the first time a corporation sells stock to the public.public.

SEC's IPO InformationSEC's IPO Information

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Common StockCommon Stock

Basic voting stock of the corporationBasic voting stock of the corporation

Ranks after preferred stock for dividend Ranks after preferred stock for dividend and liquidation distribution.and liquidation distribution.

Dividend rates are determined by the Dividend rates are determined by the board of directors based on the board of directors based on the corporation’s profitabilitycorporation’s profitability and and other factors.other factors.

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Par Value and No-par Value Par Value and No-par Value StockStock

Par value Par value – Is a Is a nominal value nominal value per share of capital stock per share of capital stock

specified in the charter.specified in the charter.– Has Has nono relationship to market value. relationship to market value.– Serves as the basis forServes as the basis for legal capital legal capital..

Legal capital is the amount of capital, Legal capital is the amount of capital, required by the state, that must remain required by the state, that must remain invested in the business.invested in the business.– It serves as a cushion for creditors.It serves as a cushion for creditors.

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Par Value and No-par Value StockPar Value and No-par Value Stock

No-par value No-par value is capital stock that does not is capital stock that does not have an amount per share specified in the have an amount per share specified in the charter. charter.

When no-par stock is issued by a When no-par stock is issued by a corporation, the amount of legal capital is corporation, the amount of legal capital is defined by the state.defined by the state.

Stated value Stated value is an amount per share that is is an amount per share that is specified by the corporation when it issues specified by the corporation when it issues no-par stock. no-par stock.

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Preferred StockPreferred StockHas dividend and liquidation preference over Has dividend and liquidation preference over common stock.common stock.

Cumulative Cumulative preferred stockpreferred stock has a preference has a preference for all past dividends over any paid to common for all past dividends over any paid to common shareholders.shareholders.

Generally does Generally does notnot have voting rights. have voting rights.

Usually has a par or stated value.Usually has a par or stated value.

Usually has a Usually has a fixed dividend rate fixed dividend rate that is stated that is stated as a percentage of the par value.as a percentage of the par value.

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Special Features of Preferred Special Features of Preferred StockStock

ConvertibleConvertible preferred stock may be preferred stock may be exchanged for common stock. (It’s up exchanged for common stock. (It’s up to the stockholder to decide.)to the stockholder to decide.)

Callable Callable preferred stock may be preferred stock may be repurchased by the corporation at a repurchased by the corporation at a predetermined price. (It’spredetermined price. (It’s

the company’s choice.)the company’s choice.)

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Accounting for Capital Stock Accounting for Capital Stock TransactionsTransactions

Two primary sources of stockholders’ equity:Two primary sources of stockholders’ equity:– Contributed capitalContributed capital

Par or stated value of issued stock.Par or stated value of issued stock.

Additional paid-in capital in excess of par or Additional paid-in capital in excess of par or stated value.stated value.

– Retained earningsRetained earningsThe cumulative net income earned by the The cumulative net income earned by the corporation less the cumulative dividends corporation less the cumulative dividends declared by the corporation.declared by the corporation.

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Accounting for the Issue of Accounting for the Issue of Common StockCommon StockWhen stock is issued, the equity When stock is issued, the equity account account Common StockCommon Stock is credited is credited (increased) for the par or stated (increased) for the par or stated value of the stock.value of the stock.

If the stock sold for more than par, If the stock sold for more than par, the additional amount is credited the additional amount is credited (increased) to the equity account (increased) to the equity account Paid in Capital in Excess of Par, Paid in Capital in Excess of Par, Common StockCommon Stock..

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Treasury StockTreasury StockA corporation’s own stock that had been A corporation’s own stock that had been issued but was subsequently reacquired issued but was subsequently reacquired and is still being held by that corporation.and is still being held by that corporation.

Why would a corporation reacquire its own Why would a corporation reacquire its own stock?stock?– To reduce the shares outstanding.To reduce the shares outstanding.– Because the market price is low.Because the market price is low.– To increase earnings per share, To increase earnings per share, if shares won’t if shares won’t

be reissued soon.be reissued soon.– To use in employee stock option programs.To use in employee stock option programs.

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Treasury StockTreasury Stock

is considered is considered issued issued stock but stock but not not outstandingoutstanding stock. stock.

has has nono voting or dividend rights. voting or dividend rights.

is a is a contra equitycontra equity account. account.

reducesreduces total stockholders’ equitytotal stockholders’ equity on on the Balance Sheet.the Balance Sheet.

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Accounting for Cash DividendsAccounting for Cash Dividends

Dividends must be declared by the Dividends must be declared by the board of board of directors directors before they can be paid.before they can be paid.

The corporation is The corporation is not legally required not legally required to to declare (and subsequently pay) dividends.declare (and subsequently pay) dividends.

Once a cash dividend is declared, a Once a cash dividend is declared, a liabilityliability (Dividends Payable) is created.(Dividends Payable) is created.

Cash dividends require sufficient Cash dividends require sufficient cashcash and and retained earnings, retained earnings, but NOT necessarily but NOT necessarily Net Income in the current yearNet Income in the current year, , toto cover the cover the dividend.dividend.

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Dividend DatesDividend DatesDate of Date of declarationdeclaration

Date of Date of recordrecord

Date of actual Date of actual paymentpayment to shareholders to shareholders

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Some interesting side trips…Some interesting side trips…

Dividend calendar McGraw HillDividend calendar McGraw Hill

Dividends are not always straightforwardDividends are not always straightforward

Dividend adviceDividend advice

DRIPsDRIPs

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Dividends on Preferred StockDividends on Preferred StockCurrent Current preferred dividends must be paid before preferred dividends must be paid before paying any dividends to common stock.paying any dividends to common stock.

If a preferred dividend is not paid, the unpaid If a preferred dividend is not paid, the unpaid amount is either cumulative (a amount is either cumulative (a dividend in dividend in arrearsarrears) or noncumulative. ) or noncumulative. – CumulativeCumulative: Unpaid dividends must be paid : Unpaid dividends must be paid

before common dividends.before common dividends.– NoncumulativeNoncumulative: Unpaid dividends are lost.: Unpaid dividends are lost.

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Calculating Preferred and Calculating Preferred and Common DividendsCommon Dividends

ABC Co. has 10 shares of $100 par, 6% ABC Co. has 10 shares of $100 par, 6% cumulative preferred stock outstanding. cumulative preferred stock outstanding. Assume that NO dividends were paid in Assume that NO dividends were paid in 19X1.19X1.

At the end of 19X2, the Board of Directors At the end of 19X2, the Board of Directors declares a declares a totaltotal of $200 worth of dividends of $200 worth of dividends for its preferred for its preferred andand common shareholders. common shareholders.

How much will go toHow much will go to the the preferredpreferred shareholders?shareholders?

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PreferredPreferred Shareholders Shareholders get their dividends first:get their dividends first:CumulativeCumulative means that the preferred shareholders get means that the preferred shareholders get all the past dividends that they were not paid (called all the past dividends that they were not paid (called “dividends in arrears” which must be footnoted, but “dividends in arrears” which must be footnoted, but NOT reported as a liability on the balance sheet) NOT reported as a liability on the balance sheet) before common stockholders can receive a dividend.before common stockholders can receive a dividend.10 preferred shares x $100 par x .06 = $60/10 preferred shares x $100 par x .06 = $60/yearyear

They get a total ofThey get a total of $120$120: $60 for 19X1 dividends in : $60 for 19X1 dividends in arrears and $60 for 19X2 current year dividend.arrears and $60 for 19X2 current year dividend.Common shareholders get the remainingCommon shareholders get the remaining $80$80. . ($80/30 shares outstanding=$2.67 per share.) ($80/30 shares outstanding=$2.67 per share.) [31 [31 shares issued - 1 still in Treasury = 30 shares outstanding.]shares issued - 1 still in Treasury = 30 shares outstanding.]

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Cash DividendsCash Dividends

What’s needed to pay cash dividends?What’s needed to pay cash dividends?– retained earningsretained earnings– cash (but, could borrow cash to pay dividend)cash (but, could borrow cash to pay dividend)– no restrictions from outsidersno restrictions from outsiders

Effects of cash dividends on financial Effects of cash dividends on financial statementsstatements– decreasesdecreases Assets (when they are actually Assets (when they are actually

paid) and Retained Earnings (dividends). paid) and Retained Earnings (dividends). – NO EFFECTNO EFFECT on Net Income. on Net Income.

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Accounting for Accounting for StockStock Dividends Dividends

StockStock dividends dividends are distributions to are distributions to stockholders of additional stockholders of additional sharesshares of stock, NOT of stock, NOT CASH!CASH!

Why issue a stock dividend?Why issue a stock dividend?Low on cash Low on cash (but want to “reward” (but want to “reward” stockholders) stockholders)

To To decreasedecrease market price of stock. market price of stock. Why?Why?

To increase number of stockholders To increase number of stockholders (assuming some of the newly issued (assuming some of the newly issued stock will be sold).stock will be sold).

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Accounting for Stock DividendsAccounting for Stock Dividends

All stockholders receive the same percentage All stockholders receive the same percentage increase in the number of shares they own increase in the number of shares they own (pro (pro rata basis)rata basis)..

No change in total stockholders’ equity.No change in total stockholders’ equity.

No change in par values.No change in par values.

Effect on financial statements? Effect on financial statements?

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Retained EarningsRetained EarningsAppropriatingAppropriating (or (or RestrictingRestricting) Retained ) Retained EarningsEarnings– Board of Directors can Board of Directors can restrict (imposed by restrict (imposed by

outsidersoutsiders) or ) or appropriate (company’s choice)appropriate (company’s choice) portions of retained earnings.portions of retained earnings.

It is a It is a way of communicatingway of communicating why more why more dividends are not being paid. dividends are not being paid. Does NOT change TOTAL Ret. EarningsDoes NOT change TOTAL Ret. Earnings. .

An appropriation (or “restriction”) only separates the An appropriation (or “restriction”) only separates the retained earnings into two categories, unappropriated retained earnings into two categories, unappropriated

and appropriatedand appropriated. . (Must have Unappropriated or (Must have Unappropriated or Unrestricted R.E. to declare dividends.) Unrestricted R.E. to declare dividends.)

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Accounting for Stock SplitsAccounting for Stock SplitsDistributions of 100% or more of Distributions of 100% or more of stock to stockholders.stock to stockholders.

Decreases par valueDecreases par value per shareper share of of stock, but stock, but total total par value stays the par value stays the same.same.

Increases number of outstanding Increases number of outstanding shares.shares.

No change in total stockholders’ No change in total stockholders’ equity.equity.

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Stock Split: exampleStock Split: exampleXYZ Co. has 1000 shares outstanding. Each XYZ Co. has 1000 shares outstanding. Each share has a $10 par value, but is selling on the share has a $10 par value, but is selling on the NYSE for $80 per share. NYSE for $80 per share.

The Company declares a 4 for 1 stock split.The Company declares a 4 for 1 stock split.

Complete the following:Complete the following: Before Before AfterAfter

# shares outstanding# shares outstandingPar value per sharePar value per shareTotal par valueTotal par valueTotal stock market valueTotal stock market valueMarket value per shareMarket value per share

1,000 $10 $10,000 $80,000 $80

4,000 $2.50$10,000$80,000 $20

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Stock Split: example continuedStock Split: example continuedXYZ Co. has 1000 shares outstanding. Each XYZ Co. has 1000 shares outstanding. Each share has a $10 par value, but is selling on the share has a $10 par value, but is selling on the NYSE for $80 per share. NYSE for $80 per share.

The Company declares a 4 for 1 stock split.The Company declares a 4 for 1 stock split.Ms. Smith owned 100 shares before the split.Ms. Smith owned 100 shares before the split.Complete the following for Ms. Smith’s stock:Complete the following for Ms. Smith’s stock:

Before Before AfterAfter # shares owned…………...# shares owned…………...Total company shares…...Total company shares…...% of stock owned………...% of stock owned………...Total market value ofTotal market value of

Ms. Smith’s stock…….Ms. Smith’s stock…….

100 1,000

10% $8,000

400 4,000 10%

$8,000 Remember, the stock price dropped from $80 to $20 per share.

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Retained EarningsRetained EarningsRepresents the net income that has been Represents the net income that has been earned less dividends that have been earned less dividends that have been declared declared since the first daysince the first day of operations of operations for the company.for the company. Example (amounts assumed)

Balance January 1, 20X1 $ 500,000 + Net income for 20X1 30,000 - Dividends for 20X1:

Cash dividends (10,000) Stock dividends ( 5,000)Balance January 31, 20X1 $ 515,000

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Retained EarningsRetained Earnings

What affects Retained Earnings?What affects Retained Earnings?– net income (through net income (through closing entriesclosing entries))– cash dividendscash dividends– stock dividendsstock dividends– prior period adjustmentsprior period adjustments

Accounting ERRORS made in previous Accounting ERRORS made in previous years that are being corrected now.years that are being corrected now.

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The End