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Stockholders’ Equity. Chapter 9. Learning Objective 1. Explain the features of a corporation. Characteristics of a Corporation. Separate Legal Entity Corporation distinct from owners; artificial person. Continuous Life/Transfer of Ownership: Company continues

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Stockholders equity l.jpg

Stockholders’ Equity

Chapter 9

©2009 Pearson Prentice Hall. All rights reserved.


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Learning Objective 1

Explain the features of a corporation

©2009 Pearson Prentice Hall. All rights reserved.


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Characteristics of a Corporation

Separate Legal Entity

Corporation distinct from

owners; artificial person

Continuous Life/Transfer of

Ownership: Company continues

to exist & operate regardless of

ownership changes

Separation of Ownership &

Management: Stockholders

elect Board of Directors who,

in turn, appoint officers

Limited Liability

Stockholders are not personally

liable for corporate debts

Corporate Taxation

Corporations are taxed on their

earnings; dividends distributed

to owners are also taxed

Government Regulation

Corporate activities are

monitored by government

regulations

©2009 Pearson Prentice Hall. All rights reserved.


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Organizing a Corporation

  • Incorporators

    • Organize the corporation

    • Pay fees

    • Sign charter

    • File documents with the state

    • Agree to bylaws

©2009 Pearson Prentice Hall. All rights reserved.


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Authority Structure in a Corporation

Stockholders

Elect the

Board of Directors

which elects the

Chair of the Board (CEO)

and the

President (Chief Operating Officer)

who leads

Vice Presidents and other corporate officers who

Manage the day-to-day operations

©2009 Pearson Prentice Hall. All rights reserved.


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Stockholders’ Rights

  • Vote at stockholder meetings

  • Receive dividends

  • Receive share if corporation liquidates

  • Maintain proportionate ownership

    • Preemptive right

©2009 Pearson Prentice Hall. All rights reserved.


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Parts of Stockholders’ Equity

  • Paid-in capital

    • Represents amounts contributed by stockholders

    • Include stock accounts

  • Retained earnings

    • Amounts earned and kept by the corporation

©2009 Pearson Prentice Hall. All rights reserved.


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Common

Basic form of common stock

Have rights of ownership

Benefit most of company succeeds

Risk most if company does not succeed

Preferred

Have preference in receiving dividends and assets in case of liquidation

Hybrid between common stock and debt

Rare for corporations to issue

Classes of Stock

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Par value

Arbitrary amount assigned to share of stock

In most states, represents minimum price for shares

Legal capital

No-par

Does not have a par value

May have a stated value

Classes of Stock

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Learning Objective 2

Account for the issuance of stock

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Issuing Common Stock at Par

  • A company issues 100,000 shares of $5 par value common stock at par

  • The common stock account is always credited in the amount of the shares issued multiplied by par value

©2009 Pearson Prentice Hall. All rights reserved.


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Issuing Common Stock Above Par

  • A company issues $100,000 shares of $5 par value stock for $12 per share

  • The amount above par is credited to Paid-in Capital in Excess of Par

(100,000 shs x $12 price)

(100,000 shs x $5 par)

What amount will make the entry balance?

©2009 Pearson Prentice Hall. All rights reserved.


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Issuing Common Stock for Noncash Assets

  • Assets recorded at their fair values

  • Common stock and paid-in capital credited accordingly

  • Suppose a company purchased equipment valued at $800,000 by issuing 50,000 shares of its $5 par common stock

Fair value of equipment

Shares issued x par value

©2009 Pearson Prentice Hall. All rights reserved.


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Preferred Stock

  • Follows the same pattern as common stock entries

    • Preferred stock is credited for the shares issued multiplied by the par value

    • A separate paid-in capital account is used if stock is issued above par

©2009 Pearson Prentice Hall. All rights reserved.


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Authorized, Issued and Outstanding

  • Authorized – maximum number of shares company can issue as indicated in its charter

  • Issued – number of shares company has sold to shareholders

  • Outstanding – number of shares currently in shareholders’ possession

    • Any difference between issued and outstanding is due to treasury stock

©2009 Pearson Prentice Hall. All rights reserved.


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Learning Objective 3

Describe how treasury stock affects a company

5-16

©2009 Prentice Hall

©2009 Pearson Prentice Hall. All rights reserved.


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Treasury Stock

  • Company’s own stock that it has issued and later reacquired

  • Reasons:

    • All authorized shares have been issued and shares are needed for employee stock purchase plans

    • Company wants to purchase its shares at a low price and the re-issue them at a higher price

    • Management want to avoid a takeover

©2009 Pearson Prentice Hall. All rights reserved.


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Accounting for Treasury Stock

  • Recorded at cost (not par value)

  • Contra-equity account (debit balance)

  • Reduces stockholders’ equity and assets

  • If sold above, paid-in capital from treasurystock transactions is credited

©2009 Pearson Prentice Hall. All rights reserved.


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Accounting for Treasury Stock

  • Suppose a company purchased 10,000 shares of its own $1 par common stock for $200,000

©2009 Pearson Prentice Hall. All rights reserved.


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Accounting for Treasury Stock

  • Later, the company resells the treasury shares for $250,000

Amount company paid to buy shares

©2009 Pearson Prentice Hall. All rights reserved.


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Retained Earnings

  • Balance = Net incomes – net losses – dividends declared

  • Accumulated earnings the company keeps

  • Not a reservoir of cash

  • Normal credit balance

  • Debit balance = Deficit

    • Losses and dividends exceed earnings

©2009 Pearson Prentice Hall. All rights reserved.


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Learning Objective 4

Account for dividends

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Dividends

  • Distribution to stockholders

  • Three forms

    • Cash

    • Stock

    • Noncash assets

©2009 Pearson Prentice Hall. All rights reserved.


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Cash Dividends

  • Company must have both:

    • Enough Retained Earnings to declare the dividend

    • Enough Cash to pay the dividend

  • Board of Directors has authority to declare the dividend

©2009 Pearson Prentice Hall. All rights reserved.


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Dividend Dates

  • Date of Declaration

    • Board of Directors announces dividend

    • Corporation is now obligated to pay

  • Date of record

    • Stockholders who own shares on this date will receive dividend

  • Date of payment

    • Payment sent to shareholders on record

©2009 Pearson Prentice Hall. All rights reserved.


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Accounting for Dividends

  • Date of Declaration

Equity Decreases; Liabilities Increase

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Accounting for Dividends

  • Date of Record – no entry

  • Date of Payment

Liabilities Decrease; Assets Decrease

©2009 Pearson Prentice Hall. All rights reserved.


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Retained Earnings

Beginning Balance

Dividends Declared

Net Income

Ending Balance

If retained earnings increases, net income > dividends

If retained earnings decreases, net income < dividends

©2009 Pearson Prentice Hall. All rights reserved.


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Preferred Dividends

  • Preferred shareholders receive dividends before common shareholders

  • Dividend rate expressed as:

    • Percent of par value

    • Dollar amount per share

  • Cumulative – any unpaid dividends are carried forward until paid

    • Dividends in arrears

©2009 Pearson Prentice Hall. All rights reserved.


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Preferred Dividend Example

  • A corporation has 10,000 shares of $100, 8% cumulative preferred stock outstanding

  • It also has 80,000 shares of $1 par common stock outstanding

  • The Board of Directors declares dividends as follows:

    • Year 1 = $ 20,000

    • Year 2 = $150,000

©2009 Pearson Prentice Hall. All rights reserved.


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Preferred Dividend Example

Preferred Dividend : 10,000 shares x $100 par x 8% = $80,000

©2009 Pearson Prentice Hall. All rights reserved.


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Stock Dividends

  • Proportional distribution of shares to stockholders

  • Reasons corporations distribute stock dividends:

    • Provide dividend, yet conserve cash

    • Reduce market price of shares

  • Decrease retained earnings and increase common stock

    • Total equity is unchanged

©2009 Pearson Prentice Hall. All rights reserved.


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Stock Dividends

  • Small

    • Less than 25% of outstanding shares

    • Recorded at market value

  • Large

    • Greater than 25% of outstanding shares

    • Recorded at par value

©2009 Pearson Prentice Hall. All rights reserved.


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E9-27

  • 10% stock dividend – small: recorded at market value

    • 10% x 500,000 shares issued = 50,000

    • Market value = $17 per share

Shares issued x market value

Shares issued x par

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E9-27

Increase by shares in stock dividends

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Stock Splits

  • Increase in shares coupled with a proportionate reduction in par value

    • 2-for-1 split doubles the shares outstanding and halves the par value

  • No entry made

    • Description of stock changed on balance sheet

©2009 Pearson Prentice Hall. All rights reserved.


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Summary of Transaction Effects

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Learning Objective 5

Use stock values in decision making

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Stock Value Terms

Price one can buy or sell one share of

stock for; varies with company

performance and economy

Market value

Set price company is required to pay to

retire preferred stock

Redemption value

Required payment to preferred

shareholders if the company liquidates

Liquidation value

Common equity

# of common shares outstanding

Book value

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Learning Objective 6

Compute return on assets and return on equity

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Return on Assets (ROA)

  • Measures company’s use of assets to earn income for financers of the business

    • Creditors

    • Stockholders

Net income + Interest expense

Average total assets

©2009 Pearson Prentice Hall. All rights reserved.


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Return on Equity (ROE)

  • Shows relationship between net income and equity

    • Computed only on common stock

  • Should be higher than return on assets

    • Stockholders risk more than bondholders

Net income – Preferred dividends

Average common stockholders’ equity

©2009 Pearson Prentice Hall. All rights reserved.


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Learning Objective 7

Report equity transactions on the statement of cash flows

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Equity Transactions on the Cash Flow Statement

  • All equity transactions are financing activities

  • Financing inflow

    • Issuing stock

  • Financing outflow

    • Purchase of treasury stock

    • Payment of dividends

©2009 Pearson Prentice Hall. All rights reserved.


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End of Chapter 9

©2009 Pearson Prentice Hall. All rights reserved.


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