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Chapter 8. The Analysis of the Statement of Shareholders’Equity. The Analysis of the Statement of Shareholders’ Equity. Link to Previous Chapter. Chapter 7 gave a design for. financial statements that. readies them for analysis. This Chapter. What is hidden. How is dirty. -. How is the.

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Chapter 8

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Chapter 8

The Analysis of the Statement of Shareholders’Equity


The Analysis of the Statement of Shareholders’ Equity

Link to Previous Chapter

Chapter 7 gave a design for

financial statements that

readies them for analysis.

This Chapter

What is hidden

How is dirty

-

How is the

This chapter reformulates the

dirty

-

surplus

surplus income

statement of

statement of owners’ equity

income ?

treated in the

owners’ equity

according to the design in

reformulation ?

reformulated

Chapter 7. The reformulation

to highlight the

information it

highlights comprehensive

contains ?

income.

Link to Next Chapter

Chapters 9 continues the

reformulation with the balance

sheet and the income

statement.

For more applications,

visit the website

Link to Web Page


What you will learn from this Chapter

  • How GAAP statements of shareholders' equity

  • are typically laid out

  • Why reformulation of the statement is

  • necessary

  • What is reported in "other comprehensive

  • income" and where it is reported

  • What "dirty-surplus" items appear in the

  • statement of shareholders' equity

  • How stock options work to compensate

  • employees

  • How stock options and other contingent equity

  • claims result in hidden expenses

  • How management can create (or lose) value for

  • shareholders with share transactions


GAAP Statement of Shareholders’ Equity

Opening book value of equity (common and preferred)

+ Net share transactions with common stockholders

+ Capital contributions (paid in capital from share issues)

- Share repurchases (into treasury stock or against paid-in capital)

+ Net share transactions with preferred shareholders

+ Capital contributions (share issues)

- Share redemptions

+ Change in retained earnings

+ Net income

- Common dividends

- Preferred dividends

+ Accumulated other comprehensive income

+ Change in unearned (deferred) stock compensation

Closing book value (common and preferred)


The Governing Accounting Relation

Book value, beginning of period

+ Comprehensive income

- Net payout to shareholders

= Book value, end of period


Reformulated Statement of Stockholders’ Equity


Reformulation: The Steps

  • Restate beginning and ending balances for items incorrectly included in or excluded from common equity

    • Preferred stock

    • Dividends payable

    • Unearned (deferred) compensation

  • Calculate net transactions with shareholders

    Cash dividends + share repurchases – share issues

  • Calculate comprehensive income

    Net income + Other comprehensive income –

    Preferred dividends


  • The GAAP Statement: Nike Inc., 2004


    Nike: The Reformulated Statement

    Balances: 2003 2004

    Reported $3,990.7 $4,781.7

    Dividends payable 36.9 52.6

    Unearned compensation 0.6 5.5

    Restated balance4,028.24,839.8


    The GAAP Statement: Reebok International Ltd., 2004


    Reebok: Reformulated Statement

    Balances:

    2003 2004

    Reported1,033.71,220.0

    Unearned compensation 1.2 5.8

    Restated balance1,034.91,225.8


    Dirty Surplus Accounting in the US


    FASB Statement No. 130

    Requires the reporting of comprehensive income

    in one of three ways

    • Within the income statement

    • In separate statement

    • Within the equity statement

      Most firms choose the last alternative


    Ratio Analysis

    Payout and Retention Ratios


    Ratio Analysis (continued)

    Shareholder Profitability Ratio

    Growth Ratios


    Hidden Dirty Surplus

    • Shareholders lose when shares are issued at less than the market price (e.g. exercise of options)

    • This loss, however, is not recorded as expense.

    • What is the nature of this loss? If options are part of a compensation package, this loss is an employee compensation expense. If from a conversion of a bond, preferred stock or warrants, the loss is a financing expense.

    • What is the amount of the loss? Market price - exercise price.

    • Special case: options granted in the money are recorded as deferred compensation


    FASB Statement No. 123R

    • Statement 123R requires an expense to be recognized at option grant date, equal to the value of the option at that date

    • Up to 2006, pro forma net income, including the expense, was reported in footnotes. The expense must now be reported in the income statement.

    • No further expense recorded as the option moves into the money or at exercise date.

    • Firms record a tax benefit (for non-qualified options) at exercise date, and credit this to shareholders’ equity.

    • IFRS2 has a similar requirement.


    Measuring the Loss from Exercise of Stock Options: Method 1 (Reebok)

    Expense is implied from the tax benefit:


    Measuring The Loss from Exercise of Stock Options: Method 2 (Reebok)

    Calculate difference between average stock price and exercise price:

    Use when tax benefit is not reported, or for incentive options (where there is no tax benefit).


    Reebok: Reformulated Statement

    Shares are issued at market value, and the difference between the market value and after-tax receipts from the shares issued is a loss from exercise of options.


    Hidden Losses on Put Options: Dell Computer

    From the 2002 equity statement (see Chapter 2):

    The Loss:


    The GAAP Statement of Shareholders’ Equity: Dell Computer, 2002


    Dell: Reformulated Statement

    Dell Computer Corporation

    Reformulated Statement of Shareholders’ Equity

    Balance, February 2, 2001 $5,696

    Transactions with shareholders:

    Shares issued in stock option exercises

    (at market)$1,747

    Shares repurchased (at market) (1,632) 115

    Comprehensive income

    Comprehensive income reported 1,222

    Loss on exercise of employee stock options $1,391

    Tax benefit for employee stock options 487 (904)

    Loss on put options (1,368) (1,050)

    Other (3)

    Balance, February 1, 2002 $4,758


    Losses on Convertible Securities

    Loss = Market price of common issued -

    Book value of convertible surrendered

    The market value method vs. the book value

    method

    - The market value method recognizes losses on

    conversion

    - The book value method records the shares at

    the book value of the convertible securities,

    with no loss recognized

    Almost all firms use the book value method.


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