Stockholders’ Equity

1. Stockholders’ Equity Chapter 9

2. Learning Objective 1 Explain the advantages and disadvantages of a corporation.

3. Characteristics of a Corporation • Separate legal entity • Continuous life and transferability of ownership • Limited liability • Separation of ownership and management • Corporate taxation • Government regulation

4. Advantages of a Corporation • Can raise more capital than a proprietorship or partnership can • Continuous life • Ease of transferring ownership • Limited liability of stockholders

5. Disadvantages of a Corporation 1. Separation of ownership 2. Corporate taxation 3. Government regulation

6. Authority Structure of a Corporation

7. Vote Dividends Liquidation Preemption Stockholders’ Rights

8. Stockholders’ Equity Two main components: • Paid-in capital (contributed capital) • Retained earnings

9. Capital Stock • Authorized shares • Outstanding shares

10. Common Stock Preferred Stock Most basic form of capital stock - issued by every corporation Has several preferences over common stock Capital Stock

11. Par Value Stock No-par Stock An arbitrary amount assigned to a share of stock Does not have par value, but may have stated value Capital Stock

12. Learning Objective 2 Measure the effect of issuing stock on a company’s financial position.

13. Common Stock at Par Suppose IHOP’s common stock has a par value of $10 per share. The company issues 6,200 shares of common stock at par. What is the entry? Jan 8 Cash (6,200 x $10) 62,000 Common Stock 62,000 To record issuance of stock ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

14. Common Stock at Par Suppose IHOP’s common stock has a par value of $0.01 per share. The company issues 6,200 shares of common stock for $10 per share. What is the entry? Jul 23 Cash (6,200 x $10) 62,000 Common Stock 62 Paid-in Capital in Excess of Par 61,938 To record issuance of stock ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

15. Common Stock Above Par Stockholders’ Equity Common Stock, $.01 par; 40,000 shares authorized, 6,200 shares issued $ 62 Paid-in capital in excess of par 61,938 Total paid-in capital $ 62,000 Retained earnings 194,000 Total stockholders’ equity $256,000 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

16. Common Stock at Par Suppose IHOP’s common stock is no par value stock. The company issues 6,200 shares of common stock for $20 per share. What is the entry? Jul 23 Cash (6,200 x $10) 124,000 Common Stock 124,000 To record issuance of stock ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

17. Preferred Stock • Accounting for preferred stock follows the pattern illustrated for common stock.

18. Learning Objective 3 Describe how treasury stock transactions affect a company.

19. Treasury Stock Transactions • Shares that a company has issued and later reacquired. • Reasons • Stock purchase plan distribution • Increase net assets • Avoidance of a takeover

20. Stockholder’s Equity at December 31, 2005 (if no treasury stock purchased) Common Stock $ 203 Paid-in capital in excess of par 69,655 Retained earnings 193,632 Total equity $263,490 IHOP Corp. Before Purchaseof Treasury Stock

21. IHOP Corp. Purchaseof Treasury Stock During 2005, IHOP paid $5,170 to purchase 288 shares of its common stock as treasury stock. Nov 1 Treasury Stock 5,170 Cash 5,170 Purchased treasury stock ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

22. Stockholder’s Equity at December 31, 2005 (with treasury stock purchased) Common Stock $ 203 Paid-in capital in excess of par 69,655 Retained earnings 193,632 Less: Treasury stock (288 shares at cost) (5,170) Total equity $258,320 IHOP Corp. After Purchaseof Treasury Stock ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

23. Sale of Treasury Stock Assume that on July 22, 2006, the shares of treasury stock are sold for $5,300. Jul 22 Cash 5,300 Treasury Stock 5,170 Paid-in Capital from Treasury Stock Transactions 130 Sold treasury stock ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

24. Stockholder’s Equity at December 31, 2006 Common Stock $ 203 Paid-in capital in excess of par 69,785 Retained earnings 193,632 Total equity $263,620 Equity before purchase of treasury stocks 263,490 Increase in stockholders’ equity $ 130 IHOP Corp. After Sale of Treasury Stock ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

25. Retirement of Stock • Decreases the outstanding stock of the corporation • Retired shares cannot be reissued • There is no gain or loss on retirement

26. Retained Earnings Account Balance = Net income less -Net losses -Dividends declared

27. Dividends and Splits • Dividend- corporation’s return to its stockholders of some of the benefits of earnings • Stock split - increase in the number of authorized, issued, and outstanding shares

28. Dividend Dates • Declaration date • Date of record • Payment date

29. Learning Objective 4 Account for dividends and measure their impact on a company.

30. Preferred Stock Dividends Pinecraft Industries, Inc., has both common stock and 100,000 shares of preferred stock outstanding. Preferred dividends are paid at the annual rate of $1.50 per share. In 20x9, the company declares an annual dividend of $1,000,000. Preferred dividend (100,000 × $1.50 per share) $150,000 Common dividend (remainder: $1,000,000 – $150,000) 850,000 Total dividend $1,000,000 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

31. Preferred Stock Dividends The preferred stock of Pinecraft is cumulative. Suppose the company passed the 20x6 preferred dividend of $150,000. In 20x7, the company declares a $500,000 dividend. Retained Earnings 500,000 Dividends Payable-Preferred 300,000* Dividends Payable-Common 200,000 Declared a cash dividend *$150,000 x 2 years ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

32. Stock Dividends • Small stock dividends: 25% or less • Large stock dividends: above 25%

33. Stock Dividend IHOP declared a 10% stock dividend in 2006. Assume IHOP had 20,000,000 shares of common stock outstanding. The stock is trading for $15 per share. How would this stock dividend be recorded?

34. Stock Dividend Retained Earnings (20,000,000 X 10% X $15) 30,000 Common Stock (20,000,000 X 10% X $0.01)20 Paid-in Capital in Excess of Par Common 29,980 Distributed a 10% stock dividend For a large stock dividend, debit Retained Earnings and credit Common Stock for the par value of the shares. ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

35. Stock Splits • Increases number of authorized, issued, and outstanding shares of stock • Proportionate reduction in stock’s par value • Decreases market price

36. Stock Splits • The market price of a share of Quaker Oats has been approximately $25. Assume that the company wants to decrease it to $12.50. This 2-for-1 split means that the company would have twice as many shares outstanding after the split as is had before the split.

37. Learning Objective 5 Use different stock values in decision making.

38. Stock Values • Market value • Redemption value • Liquidation value • Book value

39. Book Value Per Share • Preferred stock = (Redemption value + Dividendsin arrears) ÷ Number of shares of preferred outstanding • Common stock = (Total stockholders’ equity – Preferred equity) ÷ Number of shares of common stock outstanding

40. Stockholders’ Equity Preferred stock, 6%, $100 par, 5,000 shares authorized, 400 shares issued, redemption value $130 per share $ 40,000 Additional paid-in capital in excess of par – preferred 4,000 Common stock, $10 par, 20,000 shares authorized, 5,500 shares issued 55,000 Additional paid-in capital in excess of par – common 72,000 Retained earnings 85,000 Treasury stock – common, 500 shares at cost ( 15,000) Total stockholders’ equity $241,000 Book Value ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

41. Book Value Suppose that four years’ (including the current year) cumulative preferred dividends are in arrears and that preferred stock has a redemption value of $130 per share.

42. Book Value Preferred equity: Redemption value (400 shares × 130) $ 52,000 Cumulative dividends ($40,000 × $0.06 × 4 yrs) 9,600 Preferred equity $ 61,600 Common equity: Total stockholders’ equity $241,000 Less preferred equity – 61,600 Common equity $179,400 Book value per share: $179,400 ÷ 5,000 shares* $ 35.88 *5,500 shares issued minus 500 treasury shares ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

43. Learning Objective 6 Evaluate a company’s return on assets and return on stockholders’ equity.

44. Rate of Return on Total Assets (Net income + Interest expense) ÷ Average total assets Measure of a company’s ability to generate profits from the use of its assets.

45. Return on Equity Rate of return on common stockholders’ equity = (Net income – Preferred dividends) ÷ Average common stockholders’ equity Measure of income earned from common stockholders’ investment in the company.

46. Learning Objective 7 Report stockholders’ equity transactions on the statement of cash flows.

47. Reporting Stockholders’Equity Transactions During 2003, IHOP issued stock, repurchased stock, but paid no dividends. Cash flows from financing activities: Proceeds from issuance of common stock $172,000 Purchase of treasury stock (5,170,000) Net cash used by financing activities $(4,998,000) ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

48. End of Chapter 9