Reporting and Analyzing Stockholders Equity

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Principles of Accounting Kimmel Weygandt Kies
o

Reporting and Analyzing Stockholders Equity
Chapter 11
Prepared by Alice Sineath Forsyth Technical Comm
unity College And Ellen Sweat Georgia Perimete
r College
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Chapter 11 Reporting and Analyzing
Stockholders Equity

• After studying Chapter 11, you should be able
  to
  
• Identify and discuss the major characteristics of
  a corporation.
  
• Record the issuance of common stock.
• Explain the accounting for the purchase of
  treasury stock.
  
• Differentiate preferred stock from common stock.

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Chapter 11 Reporting and Analyzing Stockholders
Equity

• After studying Chapter 11, you should be able
  to
  
• Prepare the entries for cash dividends and
  understand the effect of stock dividends and
  stock splits.
  
• Identify the items that affect retained
  earnings.
  
• Prepare a comprehensive stockholders' equity
  section.
  
• Evaluate a corporation's dividend and earnings
  performance from a stockholder's perspective.

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Corporation

• Possess legal entity
• Created by law
• Has most of the rights and privileges of a
  person
  
• Classified by purpose and ownership
• Purpose - profit or nonprofit
• Ownership - publicly or privately held

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Publicly Held Corporation...

• May have thousands of stockholders and its stock
  is regularly traded on national securities
  markets.

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Privately Held Corporation...

• May have few stockholders and does not offer its
  stock for sale to general public.

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Characteristics of a Corporation

• Separate legal existence
• Limited liability of stockholders
• Transferable ownership rights
• Ability to acquire capital
• Continuous life
• Corporation management
• Government regulations
• Additional taxes

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Separate Legal Existence

• Separate and distinct from owners.
• Acts under its own name.
• May buy, own, sell property borrow money enter
  into legally binding contracts may sue or be
  sued pays its own taxes.
  
• Owners (stockholders) cannot bind corporation
  unless owners are agents of the corporation.

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Limited Liability of Stockholders

• Creditors have recourse only to corporate assets
  to satisfy claims.
  
• Liability of stockholders limited to
  investment in
  corporation.
  
• Creditors have no
  legal claim on
  personal assets
  of owners unless
  fraud has occurred.
• Stockholders losses limited to amount of
  capital invested.

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Transferable Ownership Rights

• Ownership evidenced by
  shares of stock.
  
• Transfer of ownership among
  stockholders has no effect
  on
  corporations operating
  activities or assets, liabilities
  and total stockholders'
  equity.
• Corporation does not
  participate in transfer
  of ownership
  rights after
  original sale.

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Ability to Acquire Capital

• Limited liability of stockholders coupled with
  transferable ownership rights make it easy
  to raise capital.

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Continuous Life

• Life of corporation stated in charter - may be
  perpetual or limited to specific number of years
  (can be extended).
  
• Corporation is separate
  legal entity, thus life
  not affected by
  withdrawal, death,
  or incapacity of
  stockholder.

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Forming a Corporation

• A corporation can operate in various states (must
  have a license from each state in which it does
  business) but can be incorporated in only one
  state.

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Corporation Management

• The corporation establishes by-laws upon receipt
  of its charter from the state of incorporation.
  
• Stockholders manage corporation indirectly
  through board of directors.
  
• Board of directors
• formulates operating policies
• selects officers to execute policy and to perform
  daily management functions.

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Lets Review
Which of these is not a major advantage of a
corporation?
a. separate legal existence.
b. continuous life.
c. government regulations.
d. transferable ownership rights.
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Lets Review
Which of these is not a major advantage of a
corporation?
a. separate legal existence.
b. continuous life.
c. government regulations.
d. transferable ownership rights.
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Corporate Organization Chart
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Additional Taxes

• Corporations pay federal and state income taxes.
• Stockholders pay taxes on cash
  dividends.
  
• Thus, corporate income is taxed twice.
  (double taxation)

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Stockholder Rights

• Once chartered, the corporation sells stock.
• If only one class of stock is sold - called
  common stock.
  
• Ownership rights specified in the articles of
  incorporation or by-laws.
  
• Proof of stock ownership is a printed or engraved
  form known as stock certificate.

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Stockholder Rights
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Stock Certificate Shows...

• Name of the corporation
• Stockholder's name
• Class and special features of the stock
• The number of shares owned
• The signatures of duly authorized
  corporate officials.
  

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A Stock Certificate
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Questions in Issuing Stock...

• How many shares should be authorized for sale?
• How should the stock be issued?
• At what price should the shares be issued?
• What value should be assigned to the stock?

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Authorized Stock...

• Maximum amount of stock a corporation is allowed
  to sell as authorized by corporate charter.

Outstanding Stock...
Number of shares of issued stock
that are being held by stockholders.
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Corporations Can Issue Stock...

• Directly to investors (typical in privately held
  corporations).
  
• Indirectly through an investment banking firm
  (customary with publicly held corporations).

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Factors Involved in Setting Price of Stock...

• Company's anticipated future earnings
• Its expected dividend rate per share
• Its current financial position
• Current state of the economy
• Current state of the securities market

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Par Value Stock...

• Is capital stock that has been assigned an
  arbitrary value per share in the corporate
  charter.
  
• Is usually low because some states levy a tax
  on the corporation based on par value.
  
• The legal capital per share that must be retained
  in the business.

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No-Par Value Stock...

• Capital stock that has not been assigned a value
  per share in the corporate charter.

Stated Value of No-Par Stock
Amount per share assigned by the board of
directors to no-par stock.
Par Value and Stated Value have NO
relationship to market value.
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Stockholders Equity Section of a Corporations
Balance Sheet...

• Two Parts
• Paid-in (contributed) capital
• Retained earnings (earned capital).

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Paid-in Capital...

• Amount paid to corporation by stockholders for
  shares of ownership.

Retained Earnings...
Earned capital held for future use in the
business.
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Accounting for Common Stock Issues

• The issue of common stock affects only paid-in
  capital accounts.
  
• When the issuance of common stock for cash is
  recorded, the par value of the shares is credited
  to common stock.
  
• The portion of the proceeds above or below par
  value is recorded in a separate paid-in capital
  account.

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Issuing Stock at Par

• Hydro-Slide, Inc., issues 1,000 shares of 1 par
  value of common stock at par for cash.
  
• Cash 1,000 Common Stock 1,000

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Issuing Stock Above Par

• If Hydro-Slide, Inc., issues an additional
  1,000 shares of the 1 par value common stock for
  cash at 5 per share, the entry is
  
• Cash 5,000
• Common Stock 1,000
• Paid-in Capital in 4,000
• Excess of Par Value

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Hydro-Slide, Inc. Balance Sheet (partial)

• Stockholders' equity
• Paid-in capital
• Common stock 2,000
• Paid-in capital in excess of par
  4,000
  
• Total paid-in capital 6,000
• Retained earnings 27,000
• Total stockholders' equity 33,000

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Mead, Inc. Balance Sheet (partial)

• Stockholders' equity
• Paid-in capital
• Common stock, 5 par value,
• 100,000 shares issued and
• outstanding 500,000
• Retained Earnings 200,000
• Total stockholders equity
  700,000

BEFORE TREASURY STOCK TRANSACTION
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Treasury Stock...

• Is a corporation's own stock
• that has been issued
• fully paid for
• reacquired by the corporation
• held in its treasury for future use.

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Corporations Acquire Treasury Stock to...

• Reissue shares to officers and employees under
  bonus and stock compensation plans.
  
• Increase trading of company's stock in
  securities market in hopes of enhancing market
  value.
  
• Have additional shares available for use in
  acquisition of other companies.
  
• Reduce number of shares outstanding thereby
  increasing earnings per share.
  
• Prevent a hostile takeover.

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Purchase of Treasury Stock

• On February 1, 2005, Mead acquires 4,000
  shares of its stock at 8 per share.
  
• Treasury Stock 32,000
• Cash 32,000

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Treasury Stock

• The Treasury Stock account would increase by the
  cost of the shares purchased - 32,000.
  
• The original paid-in capital account, Common
  Stock, would not be affected because the number
  of issued shares does not change.
  
• Treasury stock is deducted from total paid-in
  capital and retained earnings in the
  stockholders' equity section of the balance sheet.

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Mead, Inc. Balance Sheet (partial)

• Stockholders' equity
• Paid-in capital
• Common stock, 5 par value,
• 100,000 shares issued and
• 96,000 outstanding
  500,000
  
• Retained Earnings 200,000
• Total stockholders equity
  700,000
  
• Less Treasury Stock
  32,000
  
• Total stockholders equity 668,000

AFTER TREASURY STOCK TRANSACTION
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Preferred Stock...

• Capital stock that has contractual preferences
  over common stock in certain areas.
  
• Dividends
• Assets in the event of liquidation
• Preferred stockholders do not have voting rights.

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Preferred Stock

• Assume Corporation issues 10,000 shares of 10
  par value preferred stock for 12 cash per share.
  
  
• Cash 120,000
• Preferred Stock 100,000
• Paid-in Capital in Excess 20,000
• of Par Value--Preferred Stock
• (Preferred stock may have either a par value or
  no-par value.)

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Dividend Preferences

• Preferred stockholders have the right to share in
  the distribution of corporate income before
  common stockholders.
  
• The first claim to dividends does not guarantee
  dividends.

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Cumulative Dividend...

• Is a feature of preferred stock entitling the
  stockholder to receive current and unpaid
  prior-year dividends before common stockholders
  receive any dividends.

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Dividends in Arrears...

• Are preferred dividends that were scheduled to be
  declared but were not declared during a given
  period.
  
• Are not a liability. No liability exists until a
  dividends is declared by board of directors.
  
• Must be disclosed in the notes to the financial
  statements.

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Dividends in Arrears

• Dividends in arrears (35,000 x 2 years)
  70,000 Current-year dividends
  35,000 Total preferred dividends
  105,000

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Liquidation Preference

• Is a feature that gives preferred stockholders
  preference to corporate assets in the event of
  liquidation.
  

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Dividend...

• Is a distribution by a corporation to its
  stockholders on a pro rata basis.
  
• Pro rata means that if you own 10 of the common
  shares, you will receive 10 of the dividend.
  
• Dividend forms
• cash
• property
• script (promissory note to pay cash)
• stock

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Cash Dividend

• Is a pro rata distribution of cash to
  stockholders.
  
• A corporation must have 3 things to pay cash
  dividends
  
• Retained earnings
• Adequate cash
• Declared dividends

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Cash Dividend

• In many states, payment of dividends from legal
  capital is illegal.
  
• Payment of dividends from paid-in capital in
  excess of par is legal in some states.
  
• Payment of dividends from retained earnings is
  legal in all states.
  
• Companies are frequently constrained by
  agreements with lenders to pay dividends only
  from retained earnings.

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Entries for Cash Dividends

• Three dates are important in connection with
  dividends
  
• the declaration date
• the record date
• the payment date

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The Declaration Date...

• Is the date the board of directors declares the
  cash dividend.
  
• Commits the corporation to a binding legal
  obligation that cannot be rescinded.

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The Record Date...

• The date ownership of the outstanding shares
  is determined for dividend purposes. For Media
  General, the record date is Dec. 22. No entry is
  required on record date.

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A Stock Dividend...

• Is a pro rata distribution of the corporation's
  own stock to stockholders.
  
• Is paid in stock.
• Results in a decrease in retained earnings and an
  increase in paid-in capital.
  
• Does not decrease total stockholders' equity or
  total assets.
  
• Is often issued by companies that do not have
  adequate cash to issue a cash dividend.

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Stock Dividends

• You have a 2 ownership interest in Cetus Inc.,
  owning 20 of its 1,000 shares of common stock.
  
• In a 10 stock dividend, 100 shares (1,000 x 10)
  of stock would be issued. You would receive two
  shares (2 x 100), but your ownership interest
  would remain at 2 (22 /1,100).
• You now own more shares of stock, but your
  ownership interest has not changed.

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Reasons for Stock Dividends

• To satisfy stockholders' dividend expectations
  without spending cash.
  
• To increase marketability of its stock by
  increasing number of shares outstanding and
  decreasing market price per share.
  
• To emphasize that a portion of stockholders'
  equity has been permanently reinvested in
  business and is unavailable for cash dividends.

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Stock Dividends

• A small stock dividend (less than 20-25 of the
  corporation's issued stock) is recorded at the
  fair market value per share.
  
• A large stock dividend (greater than 20-25 of
  the corporation's issued stock) is recorded at
  par or stated value per share.

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Stock Split

• Because a stock split does not affect the
  balances in stockholders' equity accounts, it is
  not necessary to journalize a stock split.
  

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Retained Earnings...

• Is net income that is retained in the business.
• The balance in retained earnings is part of the
  stockholders' claim on the total assets of the
  corporation.
  
• Retained earnings does not represent a claim on
  any specific asset.

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Deficit...

• Is a debit balance in retained earnings and is
  reported as a deduction in the stockholders'
  equity section of the balance sheet.

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Retained Earnings Restrictions...

• Are legal, contractual or voluntary
  circumstances that make a portion of retained
  earnings currently unavailable for dividends.

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AMAZON.COM Balance Sheet (Partial) December 31
, 2000
(in thousands)

• Stockholders' equity
• Paid-in capital Common Stock
  3,571
  
• Paid-in capital in excess of par value
  1,322,479
  
• Total paid-in capital 1,326,050
• Accumulated Deficit 2,293,301
• Total stockholders equity (deficit)
  (967,251)

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Kmart, Inc. Balance Sheet (Partial) January 30
, 2002
(in millions)

• Stockholders' equity
• Common stock, 1 par value
• 1,500,000,000 shares authorized,
• 503,294,515 shares issued 503
  
  
• Capital in excess of par value
  1,695
  
• Retained earnings 1,261
• Total stockholders' equity
  3,459

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SARA LEE CORPORATION Statement of Cash Flows (p
artial) For the Year Ended June 30, 2001 (in mil
lions)

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The Payout Ratio

• CASH DIVIDENDS DECLARED ON COMMON STOCK
• NET INCOME
• measures the percentage of earnings
  distributed
  
• in the form of cash dividends to common
  stockholders.

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Return on Common Stockholders Equity Ratio

• NET INCOME - PREFERRED STOCK DIVIDENDS
• AVERAGE COMMON STOCKHOLDERS EQUITY

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Components of the Return on Common Stockholders
Equity
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Relationship of Par and No-Par Value to Legal
Capital
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The Dividend Yield

• DIVIDENDS DECLARED PER SHARE OF COMMON STOCK
• STOCK PRICE AT END OF YEAR
• reports the rate of return an investor earned
  from dividends.

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Earnings Per Share

• NET INCOME - PREFERRED STOCK DIVIDENDS
• AVERAGE COMMON SHARES OUTSTANDING
• ...measures the net income earned on each
  share of common stock.

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Price-Earnings Ratio

• MARKET PRICE PER SHARE OF STOCK
• EARNINGS PER SHARE
• In order to make a meaningful comparison of
  earnings across firms, use the price-earnings
  ratio.
  
• The price-earnings ratio reflects the investors'
  assessment of a company's future earnings.

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Stock Dividends

• Medland Corporation has 300,000 in retained
  earnings and declares a 10 stock dividend on its
  50,000 shares of 10 par value common stock.
  
• The current fair market value of the stock is 15
  per share.

Retained Earnings 75,000
Common Stock Dividends
50,000 DistributablePaid-in Capital in Excess
25,000 of Par
Value
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Stock Split...

• Is the issuance of additional shares of stock to
  stockholders accompanied by
  
• A reduction in the par or stated value.
• An increase in number of shares.
• A stock split does not have any effect on total
  paid-in capital, retained earnings, and total
  stockholders' equity.

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Lets Review
In the stockholders equity section, the cost of
treasury stock is deducted from
a. total paid-in capital and retained earnings.
b. retained earnings.
c. total stockholders equity.
d. common stock in paid-in capital.
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Lets Review
In the stockholders equity section, the cost of
treasury stock is deducted from
a. total paid-in capital and retained earnings.
b. retained earnings.
c. total stockholders equity.
d. common stock in paid-in capital.
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