A Review of the Accounting Cycle

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Equity Financing
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Learning Objectives

• 1. Identify the rights associated with ownership
  of common and preferred stock.
• 2. Record the issuance of stock for cash, on a
  subscription basis, and in exchange for noncash
  assets or for services.
• 3. Use both the cost and par value methods to
  account for stock repurchases.
• 4. Account for the issuance of stock rights and
  stock warrants.

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Learning Objectives

• 5. Explain the difference between the intrinsic
  value and fair value methods, and use both in
  accounting for a fixed stock option plan.
• 6. Distinguish between stock conversions that
  require a reduction in retained earnings and
  those that do not.
• 7. List the factors that impact the retained
  earnings balance.

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Learning Objectives
8. Properly record cash dividends, property
dividends, small and large stock dividends, and
stock splits. 9. Explain the background of
unrealized gains and losses recorded as direct
equity adjustments, and list the major types of
equity reserves founds in foreign balance
sheets. 10. Prepare a statement of changes in
stockholders equity.
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Learning Objectives
EXPANDED MATERIAL
11. Eliminate a retained earnings deficit through
a quasi-reorganization. 12. Use both the
intrinsic value and fair value methods to account
for performance-based stock option plans and
plans calling for a cash settlement.
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Components ofStockholders Equity
Stockholders
Equity
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Common Stock
The owners of common stock of a corporation can
be thought of as the true owners of the business.
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Common Stock
Unless restricted by terms of the articles of
incorporation, the common stockholder has certain
basic rights.
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Common Stock

• The right to vote in the election of directors
  and in the determination of certain corporate
  polices such as the management compensation plan
  or major corporate acquisitions.
• The right to maintain ones proportional interest
  in the corporation through purchase of additional
  common stock if and when it is issued.

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Preferred Stock
The title preferred stock is somewhat
misleading.
Preferred isnt better its different.
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Preferred Stock
The protection enjoyed by preferred stockholders
is

• Preferred stockholders are entitled to receive
  their full cash dividend before any cash dividend
  can be issued to common stockholders.
• If the company goes bankrupt, preferred
  stockholders are entitled to have their
  investment repaid in full, before common
  stockholders receive anything.

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Preferred Stock
13
Preferred Stock
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Issuance of Capital Stock
Goode Corporation issued 4,000 shares of 1 par
common stock on April 1, 2002, for 45,000 cash.
Apr. 1 Cash 45,000 Common Stock 4,000 Paid-In
Capital in Excess of Par 41,000
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Issuance of Capital Stock
Goode Corporation issued 4,000 shares of no-par
common stock with a stated value of 1 on April1,
2002, for 45,000 cash.
Apr. 1 Cash 45,000 Common Stock 4,000 Paid-In
Capital in Excess of Stated Value 41,000
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Issuance of Capital Stock
On April 1, Goode Corporation issued 4,000 shares
of no-par common stock without a stated value on
April1, 2002, for 45,000 cash.
Apr. 1 Cash 45,000 Common Stock 45,000
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Capital Stock Sold on Subscription
On November 1, 2002, a firm received
subscriptions for 5,000 shares of 1 par common
at 12.50 per share with 50 down, balance due in
60 days.
Nov. 1 Cash 31,250 Common Stock Subscription
Receivable 31,250 Common stock
Subscribed 5,000 Paid-In Capital in Excess
of Par 57,500
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Capital Stock Sold on Subscription
On December 9, received balance due on one-half
of subscribers and issued stock to fully paid
subscribers, 2,500 shares.
Dec. 9 Cash 15,625 Common Stock
Subscription Receivable 15,625
Common stock Subscribed 2,500 Common
Stock 2,500
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Stock Issued for Consideration Other Than Cash
AC Company issues 200 shares of 0.50 par value
common stock in return for land. The companys
stock is currently selling for 50 per share.
Dec. 5 Land 10,000 Common Stock 100 Paid-In
Capital in Excess of Par 9,900
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Stock Issued for Consideration Other Than Cash
Assume that the land has a readily determinable
market price of 12,000, but AC Companys common
stock has no established fair market value.
Dec. 5 Land 12,000 Common Stock 100 Paid-In
Capital in Excess of Par 11,900
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Stock Repurchases

• To provide shares for incentive compensation and
  employee savings plans.
• To obtain shares needed to satisfy requests by
  holders of convertible securities.
• To reduce the amount of equity relative to the
  amount of debt.
• To invest excess cash temporarily.

Why repurchase shares?
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Stock Repurchases

• To remove some shares from the open market in
  order to protect against a hostile takeover.
• To improve per-share earnings by reducing the
  number of shares outstanding and returning
  inefficiently used assets to shareholders.
• To display confidence that the stock is currently
  undervalued by the market.

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Treasury Stock

• Stock issued by a corporation but subsequently
  reacquired by the corporation and held for
  possible future reissuance or retirement.
• Reported as a contra-equity account, not as an
  asset.
• Does not create a gain or loss on reacquisition,
  reissuance, or retirement.
• May decrease Retained Earnings, but cannot
  increase it.

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Treasury Stock--ExampleBoth Accounting Methods
Issued 100, 10 par value shares at 15 per share
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Treasury Stock--ExampleBoth Accounting Methods
Reacquired ten shares at 16 per share.
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Treasury Stock--ExampleBoth Accounting Methods
Sold two shares of treasury stock at 20 per
share.
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Treasury Stock--ExampleBoth Accounting Methods
Sold five shares of treasury stock at 14 per
share.
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Treasury Stock--ExampleBoth Accounting Methods
Retired remaining three shares of stock.
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Stock Rights, Warrants, and Options

• Stock rights--Issued to existing shareholders to
  permit them to maintain their proportionate
  ownership interests when new shares are to be
  issued.
• Stock warrants--Sold by the corporation for cash,
  generally in conjunction with the issuance of
  another security.
• Stock options--Granted to officers or employees,
  usually as part of a compensation plan.

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Stock Warrants
Stewart Co. sells 1,000 shares of 50 par
preferred stock for 58 per share. Stewart Co.
gives the purchaser detachable warrants enabling
the holders to subscribe to 1,000 shares of 2
par common stock for 25 per share. Immediately
following the issuance of the stock, the warrants
are selling for 3, and the fair market value of
a preferred share without the warrant attached is
57.
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Stock Warrants
Value assigned to warrants
Total issue price
Market value of warrants
x

Market value of security without warrants
Market value of warrants

2,900
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Stock Warrants
The entry on Stewarts book to record the sale of
the preferred stock with detachable warrants is
Cash 58,000 Preferred Stock, 50 par
50,000 Paid-In Capital in Excess of
Par--Preferred Stock 5,100 Common Stock
Warrants 2,900
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Stock Warrants
If the warrants are exercised, the entry to
record the issuance of common stock is
Common Stock Warrants 2,900 Cash 25,000 Common
Stock, 2 par 2,000 Paid-In Capital in Excess
of Par--Common Stock 25,900
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Stock-Based Compensation
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No
Yes
All employees eligible?
No
Compensatory Plan
Shares offered equally?
No
Determine compensation expense amortize over
period employee is to provide service.
Grant and Measurement dates same?
Yes
Reasonable exercise period?
No
Yes
No
Exercise Prices Market Price?
Estimate compensation expense amortize over
period employee is to provide service.
No
Number of shares and Exercise Price known?
Non-compen- satory Plan
Yes
Determine actual expense amortize over
remaining period employee is to provide service.
Record shares issued when stock is purchased.
Record shares issued when stock is
purchased. Adjust for Unearned Compensation, if
any.
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Factors AffectingRetained Earnings
Error corrections Changes in accounting
principle Net income Quasi-reorganizations
Increases
Retained Earnings
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Factors AffectingRetained Earnings
Decreases
Changes in accounting principles Dividends
Error corrections Prior period
adjustments Treasury stock Net loss
Retained Earnings
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Accounting for Dividends

• Declaration date The date the corporations
  board of directors formally declares a dividend
  will be paid.
• Date of record The date on which stockholders
  of record are identified as those who will
  receive a dividend.
• Date of payment The date when the dividend is
  actually distributed to stockholders.

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Cash Dividend

• ABC Corporation declares a 2,000 dividend the
  following journal entries should be made

Declaration Date Dividends (Retained
Earnings) 2,000 Dividends Payable 2,000
Payment Date Dividends Payable 2,000 Cash
2,000
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Property Dividend
What is a property dividend?
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Property Dividend
It is a distribution to stockholders that is
payable in some asset other than cash.
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Property Dividend

• XYZ Corporation declares a dividend of 1,000
  shares of Gondor, Inc. stock (cost 3,000 fair
  market value, 5,000).

Date of Declaration Dividend (or Retained
Earnings) 5,000 Property Dividends
Payable 3,000 Gain on Distribution of Property
Dividend 2,000
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Property Dividend
Date of Payment Property Dividends
Payable 3,000 Investment in Gordor, Inc.
Stock 3,000
Entry on the Books of a 50 Shareholder Investment
in Gordor, Inc. Stock 2,500 Dividend
Revenue 2,500
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Stock Dividends Small or Large?

• Small
• Less than 20-25 of the outstanding shares.
• Debit Retained Earnings for the MARKET value of
  the shares.
• Large
• Greater than 20-25 of the shares outstanding.
• Debit Retained Earnings for the PAR value of the
  shares.

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Example 1 Stock Dividend

• Assume the following about Gean, Inc.
• Common stock (2 par, 10,000
• shares outstanding) 20,000
• Additional paid-in capital 24,200
• Retained earnings 12,500
• Stock dividend declared 1,500 shares
• Market price of stock 10/share

• Assume the following about Gean, Inc.
• Common stock (2 par, 10,000
• shares outstanding) 20,000
• Additional paid-in capital 24,200
• Retained earnings 12,500
• Stock dividend declared 1,500 shares
• Market price of stock 10/share

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Example 1 Stock Dividend
Because 1,500 shares represent 15 of the
outstanding stock, it is a small stock dividend.

• Assume the following about Gean, Inc.
• Common stock (2 par, 10,000
• shares outstanding) 20,000
• Additional paid-in capital 24,200
• Retained earnings 12,500
• Stock dividend declared 1,500 shares
• Market price of stock 10/share

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Example 1 Stock Dividend

• Declaration Date
• Retained Earnings 15,000
• Stock Dividends Distributable 3,000
• Paid-In Capital in Excess of Par 12,000

Issuance Date Stock Dividends Distributable 3,000
Common Stock 3,000
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Example 2 Stock Dividend

• Assume the following about Gimlis Corp.
• Common Stock (5 par, 20,000
• shares outstanding) 100,000
• Additional Paid-In Capital 100,000
• Retained Earnings 52,000
• Stock Dividend Declared 10,000 shares
• Market Price of Stock 20/share

Is this a large or small stock dividend?
50 large dividend
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Example 2 Stock Dividend

• Declaration Date
• Retained Earnings 50,000
• Stock Dividends Distributable 50,000
• Issuance Date
• Stock Dividends Distributable 50,000
• Common Stock 50,000

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Liquidating Dividend
A liquidating dividend is a distribution
representing a return to stockholders of a
portion of contributed capital.
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Disclosures Related to the Equity Section
Capital stock may be

• Authorized but unissued.
• Subscribed for and held for issuance pending
  receipt of cash for the full amount of the
  subscription price.
• Outstanding in the hands of stockholders.
• Reacquired and held by the corporation for
  subsequent reissuance.
• Canceled by appropriate corporate action.

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Quasi-Reorganization
Where state law permits, a company may eliminate
a deficit through a restatement of invested
capital balances. This provides a fresh start
for the company with a zero balance in Retained
Earnings.
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Quasi-Reorganization

• Balance Sheet for Anon., Inc.
• Before Quasi-Reorganization
• Current assets................................ 2
  50
• Land, building, and equipment........ 1,500
• Accumulated depreciation...............
  (600)
• Total assets.................................
  1,150
• Liabilities.......................................
  .. 300
• Common stock (10 par, 100 shares) 1,000
• Retained earnings...........................
  (150)
• Total liabilities and equity............ 1,150
  

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Quasi-Reorganization

• Quasi-Reorganization Plan for Anon., Inc.
• Reduce land, building, and equipment to fair
  market value of 600.
• Reduce par value of stock to 5 create 500 of
  additional paid-in capital.
• Apply 450 deficit (150 from Retained Earnings
  and 300 from fixed asset revaluation) against
  Paid-In Capital.

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Quasi-Reorganization

• Journal Entries for Anon., Inc.
• Quasi-Reorganization
• Fixed Asset Revaluation
• Retained Earnings 300
• Accumulated Depreciation 200
• Land, Building, and Equipment 500

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Quasi-Reorganization

• Revalue Common Stock
• Common Stock, 10 par 1,000
• Common Stock, 5 par 500
• Paid-In Capital from Stock
• Revaluation 500

Erase
Deficit Paid-In Capital 450 Retained
Earnings 450
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Quasi-Reorganization

• Balance Sheet
• After Quasi-Reorganization
• Current assets....................................
  . 250
• Land, building, and equipment............ 1,000
• Accumulated depreciation...................
  (400)
• Total assets....................................
  ... 850
• Liabilities.......................................
  ....... 300
• Common stock (5 par, 100 shares)... 500
• Paid-in capital...................................
  ... 50
• Total liabilities and equity..................
  850

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The End