Module 9: Stockholders

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Module 9: Stockholders

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Module 9: Stockholders Equity 1. Accounting for preferred and common 2. Treasury stock 3. Stock compensation plans 4. Retained earnings-cash dividends – PowerPoint PPT presentation

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Title: Module 9: Stockholders

1
Module 9 Stockholders Equity

1. Accounting for preferred and common
2. Treasury stock
3. Stock compensation plans
4. Retained earnings
-cash dividends
-stock dividends (and stock splits)
-property dividends (and other carve outs)
5. Other comprehensive income
6.Statement of stockholders equity
7.Convertible securities
8.Comprehensive example

2
1. Preferred Stock

Advantages
Preference over common in liquidation
Stated dividend
Variety of features regarding dividends
Preference over common in dividend payout
Disadvantages
Subordinate to debt in liquidation
Stated dividend can be skipped
No voting rights (versus common)
Debt or equity?
components of both
usually (but not always) classified with equity

3
1. Common Stock

Advantages
Voting rights
election of board of directors
vote on significant activities of management
Rights to residual profits (after preferred)
Disadvantages
Last in liquidation
No guaranteed return

4
1. Accounting for Common Stock (CS) and
Preferred Stock (PS)

Par value - initially established to create a
minimum legal capital.
Ex Minimum legal capital in some states is
1,000 for new corporations, so issue
1,000 shares at 1par, or
100 shares at 10 par, or other combination. . .
Par value is not market value.
Credit CS or PS for par value.
Excess over par credited to Paid in Capital in
Excess of Par or Stated Value or abbreviated
Additional Paid-in Capital (APIC).
Some newer stock issues (for common stock) are
no par stock.

5
1. Journal Entries

Issue PS at greater than par value
Cash xx mkt. value
Preferred Stock xx total par
APIC - PS xx excess(plug)
Issue CS at greater than par value
Cash xx mkt. value
Common Stock xx total par
APIC - CS xx excess(plug)
Note most states do not allow companies to issue
at less than par value.

6
1. Journal Entries -continued

Issue no par common stock
Cash xx mkt. value
Common Stock xx mkt. value
Note many companies have newer stock issues
that are no par, but most companies still have
older stock issues which contain a par value and
APIC.
The Stockholders Equity section of the balance
sheet of Sample Company illustrates many of the
components of SE discussed in this chapter.

7
Sample Co. Stockholders Equity

Common stock, 1 par value, 500,000 shares
authorized, 80,000 shares issued, and
75,000 shares outstanding 80,000
Common stock dividends distributable 2,000
Preferred stock, 100 par value, 1,000 shares
authorized, 100 shares issued and
outstanding 10,000
Paid in capital on common 20,000
Paid in capital on preferred 3,000
Paid in capital on treasury stock 2,000
25,000
Retained earnings
Unappropriated 18,000
Appropriated 4,000 22,000
Less Treasury stock, 5,000 shares (at cost)
(6,000)
Less Other comprehensive income (2,000)
Total Stockholders Equity 131,000

8
Journal Entries-Sample Co.

Now, using Sample Company information, record the
following additional issues of common and
preferred stock
Issued 100 shares of PS at 102 per share
Cash (100x 102) 10,200
PS (100x 100 par) 10,000
APIC - PS (plug) 200
Issued 500 shares of CS at 5 per share
Cash (500 x 5) 2,500
CS (500 x 1 par) 500
APIC - CS (plug) 2,000

9
2. Treasury Stock

Created when a company buys back shares of its
own common stock.
Reasons for buyback
reissue to employees for compensation.
hold in treasury (or retire) to increase market
price and earnings per share.
reduce total dividend payouts while maintaining
per share payouts.
thwart takeover attempts by reducing proportion
of shares available for purchase.
give cash back to existing shareholders.

10
2. Treasury Stock - continued

The debit balance account called Treasury Stock
is reported in stockholders equity as a contra
(reduces SE). Note not an asset.
The stock remains issued, but is no longer
outstanding.
does not have voting rights
cannot receive cash dividends
May be reissued (to the market or to employees)
or retired.
No gains or losses are ever recognized from these
equity transactions.

11
2. Treasury Stock(TS) - Journal Entries

There are two techniques for recording TS
transactions (Par Value method and Cost method).
We will use only the Cost method. This technique
establishes a cost for TS equal to the amount
paid to acquire the TS. Par value is not used
for TS transactions.
To record purchase of TS from market
TS xx cost
Cash xx market
(cost equals the cash paid)

12
2. Treasury Stock(TS) - Journal Entries

To reissue TS to market at greater than cost
Cash xx market
APIC - TS xx over cost
TS xx cost
To reissue TS to market at less than cost
Cash xx market
APIC - TS xx if available
Retained Earnings xx if needed
TS xx cost
debit RE if no APIC-TS available to absorb the
remaining debit difference.

13
2. TS - Example Problem

Tech Corporation has 100,000 shares of 1 par
value stock authorized, issued and outstanding at
January 1, 2005. The stock had been issued at an
average market price of 5 per share, and there
have been no treasury stock transactions to this
point.
Assume that, in February of 2005, Tech Corp.
repurchases 10,000 shares of its own stock at 7
per share. In July of 2005, Tech Corp. reissues
2,000 shares of the treasury stock for 8 per
share. In December of 2005, Tech Corp. reissues
the remaining 8,000 shares for 6 per share.
Prepare the journal entries for 2005 regarding
the treasury stock.

14
2. TS Example -Journal Entries

Feb repurchase 10,000 sh. _at_ 7 70,000.
July reissue 2,000 sh _at_ 8 16,000
(cost 2,000 _at_ 7 14,000)

TS 70,000 Cash 70,000
Cash 16,000 TS 14,000 APIC - TS 2,000
15
2. TS Example -Journal Entries

Dec reissue 8,000 sh. _at_ 6 48,000
(cost 8,000 sh._at_ 7 56,000)
Now we need to debit one or more accounts to
compensate for the difference.
(1) debit APIC-TS (but lower limit is to -0-).
(2) debit RE if necessary for any remaining
balance (this is only necessary when we are
decreasing equity).

Cash 48,000 APIC-TS (1) 2,000 RE (2)
6,000 TS 56,000
16
3. Employee Stock Compensation Plans

Historically, companies granted stock options to
employees as a means of compensating employees,
without having to recognize any compensation
expense.
Recently, the FASB required compensation expense
to be recognized on the income statement, based
on estimated fair value of the option.
Many companies have been shifting to restricted
stock plans to compensate and motivate employees.
The restricted stock plans require a recognition
of compensation expense, but based on the value
of the stock at the date of grant (rather than
fair value at date of full vesting).

17
3. Employee Stock Options-History

Since 1970, APB Opinion 25 allowed the issue of
employee stock options. When the options were
granted at the market price at grant date, no
compensation expense was necessary.
SFAS No. 123 was issued in 1995, and introduced
the fair value method for calculating the
compensation expense relating to employee stock
options.
SFAS No. 123 recommended that expense be
recognized in the income statement, but did not
require this recognition.
SFAS No. 123R was issued in 2004, to require the
recognition of expense in the income statement,
for public companies whose fiscal year begins
after June 15, 2005.

18
3. Stock Options-Illustration 1

Given the following information Em Company
adopted a stock option plan that granted options
to employees to purchase 30,000 shares of the
companys 10 par value common stock. The
options were granted on January 2, 2005, and were
exercisable 2 years after the date of grant if
the employee was still employed at the company.
The exercise price was set at 40 in the option
contract. At the date of exercise January 2,
2007, the market price was 80 per share.

19
3. Stock Options - Illustration 1

Illustration (SFAS 123R, fair value method)
Assume the market price at the date of grant was
40 per share, and the stock options are,
therefore, noncompensatory. However, compensation
expense is estimated using the Black-Scholes
option pricing model (other models are
acceptable), and the present value of the
estimated total compensation expense (based on
the projected market price at exercise) is
200,000.

20
3. Stock Options - Illustration 1

Basically, the pricing model assumes a number of
factors which could affect the growth in the
price of the stock, and also incorporates
probabilities for the number of employees that
would actually exercise the option.
Since total compensation expense 200,000, we
will recognize it over the life of the option
(200,000/2 100,000 per year).
The journal entries in Illustration 1 are
required with SFAS No. 123R.

21
3. Stock Options - Illustration 1(SFAS 123R
required journal entries)

For 2005
Compensation expense 100,000
APIC - stock options 100,000
For 2006
Compensation expense 100,000
APIC - stock options 100,000
Jan. 2, 2007
Cash (40 x 30,000) 1,200,000
APIC - stock options 200,000
Common stock (10 x 30,000) 300,000
APIC - common stock (plug) 1,100,000
Note that, even though the market price of the
stock at 1/2/07 is 80 per share, the transaction
is recorded at the PV of the estimated future
price at the date of exercise (46.67 per share).
The company never recognizes the additional
value that it has given to the employees.

22
3.Restricted Stock-Illustration 2

Given the following information Que Company
adopted a stock compensation plan that issued
10,000 shares of restricted stock to employees at
January 2, 2005. The par value of the common
stock was 10, and the stock was trading at 15
per share at the issue date. The vesting period
was 2 years after that time the stock would be
unrestricted. The journal entry at the time of
issue (1/2/05) would be (10,000 sh. x 15
150,000)
Deferred comp. expense 150,000
CS (Restricted) 100,000
APIC - CS 50,000
(Note Deferred Comp. is part of Other
Comprehensive Income, until it is transferred to
Income Statement over the 2 year vesting period.)

23
3. Restricted Stock- Illustration 2

For 2005
Compensation expense 75,000
Deferred comp. expense 75,000
For 2006
Compensation expense 75,000
Deferred comp. expense 75,000
Jan. 2, 2007 (If separate account is used for
restricted stock - transfer par value)
CS (Restricted) 100,000
CS 100,000
(Otherwise, no journal entry required the
restriction is released and the shares are no
longer restricted.)

24
3. Equity Compensation and Expense Recognition

Should compensation expense from stock options
and restricted stock plans be recognized in the
income statement?
Proponents say yes
It is a cost to the company of employing the
workers.
If the company had issued stock, then paid the
employees in cash, the amount would have been
recognized as comp. expense.
Opponents say no
The employee is essentially working as an owner
of the company, and contributing sweat equity
owners do not receive salary distributions.
Options and restricted stock are given as work
incentives, rather than straight compensation.
Remember the value can go down as well as up
(unlike traditional compensation).
These equity grants do not meet the definition of
an expense. See page 2-13.

25
4. Retained Earnings

We will be expanding the basic retained
earnings formula in this chapter. Now, the
Retained Earnings Column of the Statement of
Stockholders Equity will include the following
RE, beginning xx
Add net income xx
Less dividends
Cash dividends-common xx
Cash dividends - preferred xx
Stock dividends xx
Property dividends xx
Less Adjustment for TS transactions xx
Appropriation of RE xx
RE, ending xx

26
4. RE - Cash Dividends

As cash dividends are declared
Dividends (RE) - common xx
Dividends (RE)- preferred xx
Dividends Payable xx
As cash dividends are paid
Dividends Payable xx
Cash xx

27
4. RE - Cash Dividends

Note that stated dividends to preferred
shareholders must be paid before any dividends
can be paid to common shareholders (including
dividends in arrears if cumulative).
Preferred dividends may be cumulative, which
means that, if no dividend is declared in the
current year, they must be caught up (based on
stated dividend rate) for the preferred
shareholders in a future year before common
shareholders get any dividends.
However, cumulative preferred dividends in
arrears are not recognized as a liability until a
dividend is finally declared by the board of
directors. A company might go for a number of
years without declaring a dividend, and there is
no liability until a dividend is actually
declared.

28
4. RE - Property Dividends

Property dividends are distribution of non-cash
property by a company to its shareholders. The
most common type of property dividend is a
spin-off where the shares of stock of a
subsidiary are distributed to the shareholders of
the parent company. This is also called a form of
carve out, as the company carves out a segment
and divests it.
As property dividends are declared
Property Dividends (RE) xx
Property Div. Payable xx
As property dividends are distributed
Property Div. Payable xx
Investment xx

29
4. Other Carve Outs

Other forms of carve outs (though not considered
dividends) are sell-offs and split-offs.
In a sell-off, the company sells its equity
interest in the investment/subsidiary to an
outside party.
In a split-off, the company sells its equity
interest in the subsidiary back to the
subsidiary. Thus the subsidiary is buying back
its own shares (for treasury or retirement) and
the parent is no longer an owner.

30
4. RE - Stock Dividends

Stock dividends are distribution of additional
shares of a companys own stock to its
shareholders. Note that the distribution of
additional shares does not result in any value
being given to the shareholders.
Example 4 shareholders, each having 10 shares
of common stock. Each owner has 25 of total
(10/40). If I give each shareholder 1 additional
share of stock, each shareholder still owns 25
of the same company (11/44). Nothing has
changed, except the number of the pieces of paper.

31
4. RE - Stock Dividends

Large stock dividends (gt 25 of the outstanding
common shares) are recorded at par value.
As stock dividends are declared
Stock Dividends (RE) xx par Stock Div.
Distributable xx par
As stock dividends are distributed
Stock Div. Distributable xx par
Common Stock xx par
Note that Stock Dividends Distributable is not a
liability, it is another equity account (see
Sample Company) which indicates that there are
additional shares of stock that will be issued
but are not currently outstanding.

32
4. RE - Stock Dividends

Analyze the effect of the transactions on the
balance sheet
Stock Dividends (RE) xx -SE Stock
Div. Distributable xx SE
As stock dividends are distributed
Stock Div. Distributable xx -SE
Common Stock xx SE
Note that the total effect on stockholders
equity is zero. However, retained earnings
decreases and common stock increases by the par
value of the stock dividend.
Small stock dividends (lt 25 of the outstanding
common shares) are recorded at market value.
Since small stock dividends are rare, we will not
do journal entries here.

33
Stock Splits

Stock splits are commonly declared by a company
to reduce its market price per share. This makes
the stock more accessible to small investors.
The process for stock splits is that the old
stock is voided, and new shares are granted with
a new description.
The total par value of the new shares is equal to
the total par value of the old shares, but the
number of shares (and par value per share changes.

34
Example of Stock Split

IZM Company has 100,000 shares of 2 par value
stock authorized, 10,000 shares issued and
outstanding.
The SE section of the balance sheet shows
Common stock 20,000
Retained earnings 80,000
The market price of the outstanding shares is 50
per share before the split is distributed.

35
Example of Stock Split

If IZM declared a 2 for 1 stock split, the old
shares would be voided and new shares would be
issued with the following description
Common stock, 1 par value, 200,000 shares
authorized, 20,000 shares issued and outstanding.
The total SE is still 100,000
Common stock 20,000
Retained earnings 80,000
The market price per outstanding share would now
be 25 per share.
Note No journal entry is necessary.

36
4. Stock Dividends vs Stock Splits

Going back to the original IZM information.
Assume instead that IZM declared a 100 stock
dividend.
First, prepare the JEs to record the declaration
and distribution of the stock dividend for new
shares (10,000 shares x 100 10,000 new shares
x 2 per share 20,000)
Stock Dividends (RE) 20,000
Stock Div. Distributable 20,000
Stock Div. Distributable 20,000
Common Stock 20,000

37
4. Stock Dividends vs Stock Splits

Now note the new description for the stock
dividend
Common stock, 2 par value, 100,000 shares
authorized, 20,000 shares issued and outstanding
The total value in SE is still 100,000
Common Stock 40,000
Retained Earnings 60,000
Note that the total market price per share would
change to 25 per share.
Thus, a 2 for 1 stock split and a 100 stock
dividend have the same effect on
total stockholders equity and
market price per share

38
4. Stock Dividends vs Stock Splits

However, a stock dividend requires a journal
entry, which changes the components of SE (RE and
CS).
A stock split changes the description of the
shares, including the par value per share.
Most companies use a stock split to change the
market price per share, but some companies use
the large stock dividend to achieve the same
result. This action is called a stock split
effected in the form of a dividend.

39
4. Stock Dividends vs Stock Splits

To summarize the effects on IZM Company
100 Stock 2 for 1
After Dividend Stock Split
Total sh. outstanding 20,000 sh. 20,000 sh.
Par value per share 2 1
Market price per share 25 25
Total stockholders eq 100,000 100,000
General ledger results
CS account 40,000 20,000
RE account 60,000 80,000
Reminder CS was 20,000 and RE was 80,000
before the split or dividend ( see slide 35).
Since the stock dividend required journal entries
(see slide 36), the amounts for CS and RE
changed. Since the stock split does not require
a journal entry, the amounts for CS and RE do not
change.

40
4. RE - Appropriations

Companies may choose to restrict a portion of
their RE for dividend payout.
Reasons for this restriction may include
activities such as plans for corporate expansion
or plans for the retirement of debt.
The restriction does not create a cash balance
for these plans. It simply indicates intentions.
The restriction, or appropriation may be
indicated through disclosure, or through a
reclassification of retained earnings.

41
5. Other Comprehensive Income

Comprehensive Income is a term that was defined
in the Statements of Financial Accounting
Concepts (SFAC 6).
It consists of all non-owner changes in equity.
This includes net income as we have been defining
revenues and expenses throughout the semester,
and it also includes Other Comprehensive
Income.

42
5. Other Comprehensive Income

Other Comprehensive Income (OCI) includes
certain direct equity adjustments that are not
part of the current income statement, but which
may have eventual effect on income.
One of these adjustments was discussed in this
module deferred compensation expense.
The amount is recorded in OCI, until the effect
is transferred to the income statement.

43
5. Other Comprehensive Income

Another item in Other Comprehensive Income is the
Cumulative Translation Adjustment.
This adjustment occurs when a company owns a
foreign subsidiary, and must translate the
foreign subsidiary to U. S. dollars before
consolidating.
The adjustment would only be realized as part of
the income statement if the foreign subsidiary
was sold or liquidated for U.S. dollars.
The adjustment can be an increase or decrease,
depending on the cumulative direction of change
in the exchange rate.

44
5. Other Comprehensive Income

Other items in Other Comprehensive Income
include
Unrealized Gain/Loss on Available-for-Sale
Investments. These long term investments are
allowed to revalue each period up or down to
market. The revaluation causes a gain or loss to
be recognized (it is unrealized since the
investment has not been sold).
However, since the investment is long-term, the
gain or loss is NOT recognized in the income
statement. Instead, it is recognized
cumulatively in OCI, until the investment is
finally sold.
Similar treatment is given to certain kinds of
derivatives (a special form of investments).

45
5. Other Comprehensive Income

One other item that will be discussed comes from
a recent standard (SFAS 158), and is part of the
new requirement by FASB to fully recognize all
pension assets and liabilities in the balance
sheet.
However, FASB allows companies to defer
recognition of a portion of the pension
components, and spread the effects over future
periods. These components (costs, losses, and
gains) are deferred to OCI, until they are
recognized in future income. (More in Module 10.)
In the past, some companies recognized an OCI
adjustment for Minimum Liability, but this
requirement is no longer in effect (ignore
comment in your text).

46
6. Statement of Stockholders Equity

In this chapter, we have discussed the Statement
of Retained Earnings as the link between the
balance sheet and the income statement.
However, earlier chapters introduced the
Statement of Stockholders Equity, which has
become the default statement for large companies
in recent years.
The Statement of Stockholders Equity details the
change in retained earnings, including all the
changes discussed in this chapter, and it also
shows the change during the year in all of the
stockholders equity accounts.

47
7. Convertible Securities

Certain types of stocks and bonds may affect
stockholders equity.
Preferred stock may be issued with a convertible
privilege, which allows investors to convert to
common stock at a predetermined ratio. This
conversion is usually recorded at book value of
the preferred stock, and no cash is required in
the exchange.
Convertible bonds allow the investor to convert
the bonds to common stock at a predetermined
ratio. The conversion is similar to that for
preferred stock, but in this case, liabilities go
down and equity goes up.
These convertible securities will have an effect
on earnings per share calculations, particularly
diluted earnings per share (see Module 5).

48
8. Comprehensive Class Problem - Stockholders
Equity

Given the following SE balances for Company G at
1/1/08
Common stock, 10 par, 50,000 shares authorized,
20,000 shares issued and outstanding
200,000
APIC on common stock 400,000
Retained earnings 400,000
During 2008, Company G had the following
activity
1. Net income for the year was 250,000.
2. Cash dividends of 2 per share were declared
and paid on February 1.
3. On June 1, Company G repurchased 2,000 shares
of its own stock at 20 per share (using the cost
method).
4. On December 1, Company G reissued 500 shares
of treasury stock at 18 per share.
5. On December 15, Company G declared a 100
stock dividend, to be distributed to all of its
shareholders (including treasury), on Jan. 15,
2009.
6. At Dec. 31, Company G recorded an AJE to
revalue its available for sale investments from
20,000 to 32,000.

49
Comprehensive Class Problem - Stockholders
Equity (continued)

Required
A.Prepare journal entries for items 2 through 6
(item 1 would require detail information for
revenues and expenses to prepare - just know that
the credit is to retained earnings for 250,000).
B.Prepare the Statement of Stockholders Equity
for Company G for 2008.
C.Prepare the stockholders equity section of the
balance sheet for Company G for 2008, including
the appropriate description for the common stock.

50
Comprehensive Class Problem - Solution

A.Journal entries
1.No entry required.
2. Calc 20,000 x 2 40,000
3. Calc 2,000 shares x 20 40,000

51
Comprehensive Class Problem - SolutionPart A
Journal Entries

4.Calc 500 shares x 18 market 9,000
500 shares x 20 cost 10,000
5.Calc 20,000 new shares x 10 par 200,000
Note in Item 5, the stock has not yet been
distributed, so we cannot credit common stock, or
show it issued yet. This Stock Dividends
Distributable account is a related equity
account, and indicates that there are shares of
stock to be distributed in the future.

52
Comprehensive Class Problem - SolutionPart A
Journal Entries

6. Calc value up 12,000
Note that the Unrealized Gain account is part
of stockholders equity (not the income
statement), and it is located as a separate
column called Other Comprehensive Income (OCI) in
the Statement of Stockholders Equity .

53
Comprehensive Class Problem - SolutionPart B
Statement of SE (in thousands)

CS CSDD APIC RE OCI TS
Balance 1/1/08 200 400 400
Net income 250
Cash dividends (40)
Stock dividends 200 (200)
Purchase of TS (40)
Reissue of TS ( 1) 10
Revalue AFS Invest. 12
Balance, 12/31/08 200 200 400 409
12 (30)
Note CSDD is Common Stock Dividends
Distributable. When shares distributed, then CS
is increased.
Note OCI is Other Comprehensive Income and
reflects the unrealized gain on Available-for
-sale investment.