Shareholders’ Equity

1. Insert Book Cover Picture Shareholders’ Equity 18

2. Assets – Liabilities = Shareholders’ Equity The Nature of Shareholders’ Equity Net Assets(Residual Interest)

3. Sources of Shareholders’ Equity Amounts earnedby corporation Amounts investedby shareholders Other gains and losses not included in net income Shareholders’ Equity Paid-in Capital Retained Earnings Accumulated Other Comprehensive Income

4. The Corporate Organization Advantages: • Ease of raising capital. • Ease of ownership transfer. • Limited liability. • Continuous existence. Disadvantages: • Double taxation. • Government regulation.

5. Hybrid Organizations Doubletaxationavoided. S Corporation • Limited liability protection of a corporation. • Maximum number of owners. Limited liability company • Limited liability protection of a corporation. • All owners may be involved in managementwithout losing limited liability protection. • No limit on number of owners. Limited liability partnership • Owners are liable for their own actions but not entirely liable for actions of other partners.

6. Nature and locationof business activities. Number and classesof shares authorized. Composition of initialboard of directors. Formation of a Corporation Corporate Charter

7. Articles of incorporationare filed with the state. Board of directors appoint officers. State issues a corporate charter. Board of directors elected by shareholders. Shares of stock issued. Formation of a Corporation

8. Authorized Shares Authorized, Issued, and Outstanding Capital Stock The maximum number of shares of capital stock that can be sold to the public is called the authorized number of shares.

9. Authorized Shares Authorized, Issued, and Outstanding Capital Stock Issued sharesare authorized shares of stock that have been sold. Unissued shares are authorized shares of stock that have never been sold.

10. Outstanding sharesare issued shares that are owned by stockholders. Authorized Shares Issued Shares Treasury sharesare issued shares that have been reacquired by the corporation. Authorized, Issued, and Outstanding Capital Stock Outstanding Shares Unissued Shares Treasury Shares

11. Outstanding sharesare issued shares that are owned by stockholders. Authorized Shares Retired sharesassume the same status as authorized but unissued shares. Authorized, Issued, and Outstanding Capital Stock Outstanding Shares Unissued Shares Retired Shares

12. Common Preferred Types of Capital Stock

13. Common Stock The basic voting stock of the corporation. Ranks after preferred stock for dividend and liquidation distribution. Dividends determined by the board of directors.

14. Preferred Stock Usually has apar or stated value. Generally does nothave voting rights. Preference over common stock in the event of liquidation. Dividend preference over common stock.

15. Preferred Stock Dividends Are usually stated as a percentage of the par or stated value. May be cumulative or noncumulative. May be partially participating, fully participating, or nonparticipating.

16. Preferred Stock DividendsCumulative Unpaid dividends must be paid before any distributions to common stock. Dividends in arrearsare not liabilities, but must be disclosed.

17. Net holding losses (gains) on investments. Deferred losses (gains) from derivatives. Postretirement plans: Losses (gains) Prior service cost. Losses (gains) from foreign currency translations. Comprehensive Income Comprehensive income includes losses and gains that traditionally havebeen excluded from net income.

18. Comprehensive Income Components of comprehensive income created during the reporting period: ($ in millions) Net income $xxx Other comprehensive income: Net unrealized holding gains (losses) on investments(net of tax)† $ x Losses (gains) on postretirement benefit plans(net of tax)‡ (x) Prior service cost on postretirement benefit plans(net of tax)# x Deferred losses (gains) from derivatives(net of tax)§ x Losses (gains) from foreign currency translation(net of tax)* x xx Comprehensive income$xxx † Changes in the market value of securities available-for-sale. ‡ Increases (decreases) in the postretirement benefit obligation from changing assumptions as well as plan assets earning less or more than expected (described in Chapter 17). #Cost of recalculating postretirement benefits in prior years after amending a plan. (described in Chapter 17). § When a derivative designated as a cash flow hedge is adjusted to fair value, the gain or loss is deferred as a component of comprehensive income and included in earnings later, at the same time as earnings are affected by the hedged transaction (described in the Derivatives Appendix to the text). * Gains or losses from changes in foreign currency exchange rates. The amount could be an addition to or reduction in shareholders’ equity. (This item is discussed elsewhere in your accounting curriculum.)

19. The accumulated amount of comprehensive income is reported as a separate item of SE in the balance sheet. There are 3 options for reporting comprehensive income created during the reporting period. The statement of comprehensive income can be presented: As an expanded version of the income statement. Within the statement of shareholders’ equity. As a separate statement. Comprehensive Income Comprehensive income (a) is reported periodicallyas it is created and (b) also is reported as a cumulative amount.

20. SHARES SOLD FOR CASH Dow Industrial sells 100,000 of its common shares, $1 par per share, for $10 per share: ($ in 000s) Cash (100,000 shares at $10 price per share) 1,000 Common stock (100,000 shares at $1 par ) 100 Paid-in capital – excess of par (remainder) 900 The entire proceeds from the sale of nopar stock are recorded in the stock account: Cash (100,000 shares at $10 price per share) 1,000 Common stock 1,000

21. Issuing Stock for Noncash Assets Record the transaction at fair value(of stock issued or of asset or service received, whichever is more clearly evident). If market values cannot be determined, use appraised values.

22. Issuing Stock for Noncash Assets DuMont Chemicals issues 1 million of its common shares, $1 par per share, in exchange for a custom-built factory for which no cash price is available. Today’s issue of the Wall Street Journal lists DuMont’s stock at $10 per share: ($ in millions) Property, plant, & equipment (1 million sh at $10) 10 Common stock (1 million shares at $1 par) 1 Paid-in capital – excess of par (remainder) 9 We record both the asset and the stock at the $10 million fair value.

23. Allocate the amount received based on the relative fair values of the two securities. If only one fair value is known, allocate a portion of the amount received based on that fair value and allocate the remainder to the other security. More Than One Security Issuedfor a Single Price

24. More Than One Security Issuedfor a Single Price AP&P issues 4 million of its common shares, $1 par per share, and 4 million of its preferred shares, $10 par, for $100 million. Today’s issue of the Wall Street Journal lists AP&P’s common at $10 per share. There is no established market for the preferred shares: ($ in millions) Cash 100 Common stock (4 million shares x $1 par) 4 Paid-in capital – excess of par, common 36 Preferred stock (4 million shares x $10 par) 40 Paid-in capital – excess of par, preferred 20 $100 - 40 = $60 million 4 million shares x $10 = $40 million

25. Registration fees • Underwriter commissions • Printing and clerical costs • Legal and accounting fees • Promotional costs Share Issue Costs Share issue costsreduce net proceedsfrom selling shares, resulting in a loweramount of additional paid-in capital.

26. Share Buybacks A corporation might reacquire shares of its stock to . . . • Support the market price. • Increase earnings per share. • Distribute in stock option plans. • Issue as a stock dividend. • Use in mergers and acquisitions. • Thwart takeover attempts.

27. I can account forthe reacquired sharesbyretiring them or byholding them astreasury shares. Share Buybacks

28. Accounting for Retired Shares When shares are formally retired, we reduce the same capital accounts that were increased when the shares were issued – common or preferred stock, and additional paid-in capital.

29. Accounting for Treasury Stock Acquisition of Treasury Stock • Recorded at cost to acquire. Resale of Treasury Stock • Treasury Stock credited for cost. • Difference between cost andissuance price is (generally)recorded in paid-in capital –share repurchase.

30. COMPARISON OF SHARE RETIREMENT AND TREASURY STOCK ACCOUNTING American Semiconductor’s balance sheet included the following: Shareholders' Equity ($ in millions) Common stock, 100 million shares at $1 par $ 100 Paid-in capital – excess of par 900 Paid-in capital – share repurchase 2 Retained earnings 2,000

31. COMPARISON OF SHARE RETIREMENT AND TREASURY STOCK ACCOUNTING Reacquired 1 million of its common shares Retirement Treasury Stock Case 1: Shares repurchased at $7 per share Common stock ($1 par x 1 million sh) 1 Treasury stock (cost) 7 PIC – excess of par ($9 per sh) 9 PIC – share repurchase (difference) 3 Cash 7 Cash 7 OR Case 2: Shares repurchased at $13 per share Common stock ($1 par x 1 million sh) 1 Treasury stock (cost) 13 PIC – excess of par ($9 per sh) 9 PIC – share repurchase 2* Retained earnings (difference) 1 Cash 13 Cash 13 We credit PIC – share repurchase for the amount needed to make debits equal credits in the entry. We reduce common stock and PIC – excess of parthe same amounts they were increased when the shares were issued: Cash 10 Common stock 1 PIC – excess of par 9 *Because there is a $2 million credit balance.

32. SUBSEQUENT SALE OF SHARES Sold 1 million shares after reacquiring shares at $13 per share (Case 2 in previous situation) Retirement Treasury Stock Case A: Shares sold at $14 per share Cash 14 Cash 14 Common stock (par) 1 Treasury stock (cost) 13 PIC – excess of par 13 PIC – share repurchase 1 OR Case B: Shares sold at $10 per share Cash 10 Cash 10 Common stock (par) 1 RE (to balance) 1 PIC – excess of par 9 PIC – share repurchase 2* Treasury stock (cost) 13 *Because there is a $2 million credit balance.

33. REPORTING SHARE BUYBACKS IN THE BALANCE SHEET Formally retiring shares restores the balances in both the Common stock account and Paid-in capital – excess of par to what those balances would have been if the shares never had been issued at all. eAny net increase in assets resulting from the sale and subsequent repurchase is reflected as Paid-in capital – share repurchase. eAny net decrease in assets resulting from the sale and subsequent repurchase is reflected as a reduction in retained earnings.

34. REPORTING SHARE BUYBACKS IN THE BALANCE SHEET Shares Treasury Retired Stock Shareholders’ Equity($ in millions) Paid-in capital:Common stock, 100 million shares at $1 par $ 99 $ 100Paid-in capital – excess of par 891 900Paid-in capital – share repurchase 2 Retained earnings 1,999 2,000 Less: Treasury stock, 1 million shares (at cost) (13) Total shareholders’ equity$2,989$2,989 When a share repurchase is viewed as treasury stock, the cost of the treasury stock is simply reported as a reduction in total shareholders’ equity.

35. Accounting for Treasury Stock In 2006, Peridot, Inc. reacquired 3,000 shares of its common stock at $55 per share. In 2007, Peridot, Inc. reissued 1,000 shares of the stock at $75 per share. Which of the following would be included in the 2007 entry? a. Credit Cash for $165,000. b. Debit Treasury Stock for $75,000. c. Credit Treasury Stock for $55,000. d. Credit Cash for $75,000.

36. Accounting for Treasury Stock 2006 Treasury stock 165,000 Cash 165,000 2007 Cash 75,000 Treasury stock 55,000 PIC - share repurchase 20,000

37. Retained Earnings Represents the undistributed earnings of the company since its inception.

38. Cash Dividends Dividends must bedeclared by the boardof directors beforethey can be paid. Cash dividendsrequire sufficient cashand retained earningsto cover the dividend. A corporation is notlegally requiredtopay dividends. When a dividend isdeclared, a liabilityis created.

39. CASH DIVIDENDS On June 1, the board of directors of Craft Industries declares a cash dividend of $2 per share on its 100 million shares, payable to shareholders of record June 15, to be paid July 1: ($ in millions) June 1 – declaration date Retained earnings 200 Cash dividends payable (100 million shares at $2/share) 200 June 13 – ex-dividend date no entry June 15 – date of record no entry July 1 – payment date Cash dividends payable 200 Cash 200

40. June Dividend Dates Ex-dividend date • The first day the shares trade without the right to receive the declared dividend. (No entry) X

41. July June X Dividend Dates Date of record • Stockholders holding shares on this date will receive the dividend.(No entry) X

42. PROPERTY DIVIDENDS On October 1, the board of directors declares a property dividend of 2 million sh. of preferred stock that Craft had purchased in March as an investment (book value: $9 million; FV: $5/sh), payable to shareholders of record October 15, to be distributed November 1: October 1 – declaration date($ in millions) Investment in Beaman Corporation preferred stock 1 Gain on appreciation of investment ($10 – $9) 1 Retained earnings (2 million shares at $5 per share) 10 Property dividends payable 10 October 15 – date of record no entry November 1 – payment date Property dividends payable 10 Investment in Beaman Corporation preferred stock 10 Before recording a property dividend, the asset first must be written up to fair market value. Then record the property dividend the same way as a cash dividend.

43. STOCK DIVIDENDS A stock dividend is the distribution of additional shares of stock to current shareholders of the corporation. Because each shareholder receives the same percentage increase in shares, shareholders' proportional interest in (percentage ownership of) the firm remains unchanged. Craft declares and distributes a 10% common stock dividend (10 million shares) when the market value of the $1 par common stock is $12 per share: ($ in millions) Retained earnings (10 million shares at $12 per share) 120 Common stock (10 million shares at $1 par per share) 10 Paid-in capital – excess of par (remainder) 110 For a "small" stock dividend (less than 25%), the fair market value of the additional shares distributed is transferred from retained earnings to paid-in capital.

44. STOCK SPLITS A stock distribution of 25% or higher is referred to as a stock split. A frequent reason for issuing a stock split is to reduce the market price per share (by half in a 2 for 1 split, for example). No journal entry, unless the stock distribution is referred to as a "stock split effected in the form of a stock dividend." Craft declares and distributes a 2 for 1 stock split effected in the form of a 100% stock dividend (100 million shares) when the market value of the $1 par common stock is $12 per share: ($ in millions) Paid-in capital – excess of par 100 Common stock (100 million shares at $1 par) 100 Some companies choose to debit retained earnings instead.

45. End of Chapter 18