Special Acquisitions: Financing a Business with Equity

1

• Chapter 9
• Special Acquisitions Financing a Business with
  Equity

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Equity in Corporations

• The equity section for a corporation is divided
  into two parts
• Contributed Capital ( paid-in-capital)--this is
  the amount that owners have contributed this
  includes
• Capital Stock
• Additional paid-in-capital
• Retained Earnings--this is what the company has
  earned over its whole life, less any dividends
  paid out

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Authorized, Issued, and Outstanding Capital Stock
Authorized Shares
Owned by stockholders
Unissued Shares
Outstanding Shares
Issued Shares
Treasury Shares
Reacquired by corporation
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Common Stock

• Basic voting stock of the corporation
• Ranks after preferred stock for dividend and
  liquidation distribution.
• Dividend rates are determined by the board of
  directors based on the corporations
  profitability.
• Par value - nominal value per share of capital
  stock specified in the charter.
• Has no relationship to market value.
• Serves as the basis for legal capital.
• It serves as a cushion for creditors.
• No par value stock legal capital specified by
  the state
• Stated value specified when it is no par value
  stock

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Preferred Stock

• Has dividend and liquidation preference over
  common stock.
• Cumulative preferred stock has a preference for
  all past dividends over any paid to common
  shareholders.
• Generally does not have voting rights.
• Usually has a par or stated value.
• Usually has a fixed dividend rate that is stated
  as a percentage of the par value.

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On Feb 23, ABC Co. issued 300 shares of 10 par
common stock for 12 per share.

• Assets Liab. Cont. Cap. Ret.
  Earnings

3600 (Cash)
3000 (Common Stock at par)
600 (PIC in excess of par)
Income Statement Statement of Changes in
Equity Statement of Cash Flows
No effect on Income Increases equity Increases
cash flow
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Accounting for the Issue of Common Stock

• How would the issuance of common stock be
  recorded in the journal?
• Date Transaction Debit Credit

Feb 23 Cash 3,600 Common stock
3,000 Paid-in capital in excess of par
600
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Treasury Stock

• A corporations own stock that had been issued
  but was subsequently reacquired and is still
  being held by that corporation.
• Why would a corporation reacquire its own stock?
• To reduce the shares outstanding.
• Because the market price is low.
• To increase earnings per share.
• To use in employee stock option programs.
• Treasury stock
• is considered issued stock but not outstanding
  stock.
• has no voting or dividend rights.
• is a contra-equity account.
• reduces total stockholders equity on the
  Balance Sheet.

9
On April 10, ABC Co. bought back 20 shares of its
10 par common stock for 11 per share (issued in
previous transaction)

• Assets Liab. Cont. Cap. Ret.
  Earnings
• 
  -220
  (Cash) -220 (Treasury Stock)
  

Income Statement Statement of Changes in
Equity Statement of Cash Flows
No effect on Income Decreases equity Decreases
cash flow
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Accounting for Treasury Stock

• How would the purchase of treasury stock be
  recorded in the journal?
• Date Transaction Debit Credit

Apr 10 Treasury stock 220 Cash 220
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Treasury Stock Transactions

• Treasury stock is recorded at cost.
• The account, Treasury Stock, is contra to all of
  Equity and subtracted at the end of the section
  on the Balance Sheet.
• If the treasury stock is subsequently resold for
  more than the cost, another equity account, PIC
  Treasury Stock, would be credited for the excess
  over cost
• NO gains or losses are recorded on the purchase
  or on the reissue of treasury stock.
• Examples
• Reselling treasury stock above cost
• Reselling treasury stock below cost

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Accounting for Cash Dividends

• Dividends must be declared by the board of
  directors before they can be paid.
• The corporation is not legally required to
  declare dividends.
• Once a dividend is declared, a liability is
  created.
• Cash dividends require sufficient cash and
  retained earnings to cover the dividend.
• Date of declaration
• Date of record
• Date of actual payment to shareholders

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Dividends on Preferred Stock

• Current preferred dividends must be paid before
  paying any dividends to common stock.
• If a preferred dividend is not paid, the unpaid
  amount is either cumulative (a dividend in
  arrears) or noncumulative.
• Cumulative Unpaid dividends must be paid before
  common dividends.
• Noncumulative Unpaid dividends are lost.

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Calculating Preferred and Common Dividends

• Suppose ABC Co. has 1000 shares of 100 par, 6
  cumulative preferred stock outstanding and that
  NO dividends were paid in 1996.
• At the end of 1997, the Board of Directors
  declares a total of 20,000 worth of dividends
  for its preferred and common shareholders.
• How much will go to the preferred shareholders?
• Cumulative means that the preferred shareholders
  get all the past dividends that they were not
  paid.
• 1000 x 100 x .06 6,000
• They get a total of 12,000 6,000 for 1996 and
  6,000 for 1997.
• Common shareholders get the remaining 8,000.
• If it is non cumulative, then the preferred
  stockholders will get just 6,000 for 1997 the
  common shareholders will get the rest.

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The Effect of Declaring the Dividends

• Assets Liabilities CC RE
• 20,000 div/payable, (20,000)

When dividends are declared Dividends
20,000 Dividends payable 20,000 When cash
is paid Dividends payable 20,000 Cash
20,000 Overall Equity (dividends reduce retained
earnings) decreases Assets (cash is paid)
decrease No effect on income
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Accounting for Stock Dividends

• Stock dividends are distributions to stockholders
  of additional shares of stock.
• Why issue a stock dividend?
• Low on cash.
• To decrease market price of stock.
• To increase number of stockholders (assuming some
  of the newly issued stock will be sold).
• All stockholders receive the same percentage
  increase in the number of shares they own (pro
  rata basis).
• No change in total stockholders equity.
• No change in par values.

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ABC Co. declared a 10 stock dividend on its 200
shares of 1 par common stock. The market value
at the time of distribution is 20.

• Assets Liab. Cont. Cap. Ret.
  Earnings
• 20 (C/S) -400
• 380 (Addl P-I-C)

Income Statement Statement of Changes in
Equity Statement of Cash Flows
No effect on Income No effect on equity No effect
on cash flow
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Accounting for The Declaration of Stock Dividends

• How would the declaration of dividends be
  recorded in the journal?
• Date Transaction Debit Credit

Dec 31 Dividends (or R/E) 400 Common stock
(par) 20 Paid-in capital in excess of par
380
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Accounting for Stock Splits

• Distributions of 100 or more of stock to
  stockholders.
• Decreases par value of stock.
• Increases number of outstanding shares.
• No change in total stockholders equity.

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Retained Earnings

• Represents the income that has been earned less
  dividends that have been paid out since the first
  day of operations for the company.
• What affects Retained Earnings?
• net income
• cash dividends
• stock dividends
• prior period adjustments
• Appropriating Retained Earnings
• Board of Directors can restrict portions of
  retained earnings (a communication device)