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Certificate of Stock. Chapter 11. Stockholders’ Equity. Financial Accounting 4e by Porter and Norton. Disadvantages. Advantages. Equity Financing: Issue Stock. Dividend flexibility Ready markets Often provides higher ROI than debt financing Borrowing may not be feasible. Advantages.

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Chapter 11

Certificate of Stock

Chapter 11

Stockholders’ Equity

Financial Accounting 4e by Porter and Norton


Equity financing issue stock

Disadvantages

Advantages

Equity Financing: Issue Stock

  • Dividend flexibility

  • Ready markets

  • Often provides higher ROI than debt financing

  • Borrowing may not be feasible


Equity financing issue stock1

Advantages

Disadvantages

Equity Financing: Issue Stock

  • Less control

  • Dividends not tax deductible

  • Hurts some financial ratios


Expanded accounting equation

Expanded Accounting Equation

Assets = Liabilities + Owners’ Equity

Assets = Liabilities + Stockholders’ Equity

Contributed

Capital

Retained

Earnings


Relationships among financial statements winnebago industries inc

Income Statement for 2001

Revenues$ xxx

Less: expenses xxx

Net income$ 42,704

Relationships among Financial Statements – Winnebago Industries, Inc.

Statement of Change in Stockholders’ Equity for 2001

Beginning balance, reinvested income$ 195,556

Add: Net income42,704

Deduct: Cash dividends ( 4,121)

Ending balance, reinvested income$ 234,139

Balance Sheet as of August 25, 2001

Total Assets$xxx

Total Liabilitiesxxx

Capital Stockxxx

Reinvested Earnings 234,139

Total Liabilities & Stockholders' Equity$ xxx


Stockholders equity components

Common

Stock

Preferred

Stock

Addt’l.

Paid-In Cap.

Retained

Earnings

Deduct:

Treasury

Stock

Other

Misc.

Donated

Capital

Stockholders’ Equity Components


Amr corporation s partial balance sheet

AMR Corporation’sPartial Balance Sheet

(in millions)

20012000

Shareholders' equity:

Preferred stock, 20 million shares authorized; none

issued -- --

Common stock, $1 par value, 750 million shares

authorized; 182,278,766 shares issued 182 182

Additional paid-in capital 2,865 2,911

Treasury shares at cost: 2001 – 27,794,380; 2000 –

30,216,218 (1,716)(1,865)

Accumulated other comprehensive loss (146) (2)

Retained earnings4,1885,950

Total shareholders' equity 5,3737,176


Contributed capital

Certificate

of Stock

Contributed Capital

  • Common Stock

    • basic stock of corporation

    • has voting rights

    • represents ownership interest

  • Preferred Stock

    • optional

    • tailored to meet specific needs

    • provides dividend returns with less risk


Number of shares of stock

Maximum

Allowable

1,000

Number of Shares of Stock

Authorized

Issued -sold &

distributed

Outstanding - not

repurchased or retired


Par value

Certificate of Stock

$1.00 Par Value

Par Value

  • “Legal capital”

  • Arbitrary amount stated on stock certificate

  • also called “stated value”


Additional paid in capital

Certificate of Stock

$1.00 Par Value

15

Additional Paid-in Capital

  • Amount received in excess of par or stated value of stock


Retained earnings

Retained Earnings

  • Net income retained in business (not paid out as dividends) since inception

  • Reinvested in a variety of assets (not necessarily liquid)


Preferred stock

$100 par,

7% Preferred Stock

Preferred Stock

  • Can tailor to specific needs of firm

  • Stated dividend rate

  • Often carries dividend preference over common stock


Preferred stock features

Cumulative

Participating

Callable

Convertible

1994

1995

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1996

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Preferred

Common

Preferred Stock Features


Stock issued for cash

Stock Issued for Cash

Example:

Journal Entry:

Cash 15,000

Common Stock 10,000

Additional Paid-In Capital – Common 5,000

Common Stock $ 10,000

( $10 par value x 1,000 shares)

1,000 shares of

$10 par value stock

sold for $15 per share

Addt’l Paid-In Cap. $5,000

(($15 - $10) x 1,000 shares)


Stock issued for noncash consideration

Certificate of Stock

Stock Issued for Noncash Consideration

  • Record at fair market value of consideration given or received, whichever is more readily determinable

Title

to land,

building,

etc.


Treasury stock

Certificate of Stock

Treasury Stock

  • Company buys back its own stock

  • Contra-equity account (debit balance)

  • Not outstanding (no voting rights)


Reasons for repurchasing stock

Reasons for Repurchasing Stock

  • Provide for bonus or benefit plans

  • Maintain favorable market value

  • Improve financial ratios

  • Maintain control of ownership

  • Cash in on future price increases


Presentation of treasury stock

Presentation of Treasury Stock

Common stock, $10 par, 1,000

shares issued, 900 outstanding$ 10,000

Additional paid-in capital 12,000

Retained earnings 15,000

37,000

Less: Treasury stock, 100 shares

at cost ($25 per share) ( 2,500)

Total stockholders’ equity$34,500


Cash dividends

Date

dividend check for

Jane Doe

Dept.. of Treasurer

on

1

2

3

1

2

3

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10

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Date of

declaration

Payment

date

Cash Dividends

Paid

to

Stockholders

on date of record


Dividends

Dividends

Record dividends when declared; not when paid

12/31/03

1/15/04

Reduce

retained

earnings

Pay

dividends


Recording cash dividends

Date

dividend check for

Jane Doe

Dept.. of Treasurer

Recording Cash Dividends

Retained EarningsXXX

Cash Dividend Payable XXX

To record the declaration of a cash dividend.

Cash Dividend Payable XXX

CashXXX

To record dividend payment.


Dividend requirements

Dividend Requirements

  • Sufficient cash

  • Positive retained earnings


Dividend payout ratio

Date

Dividend check for

Jane Doe

I.M. Treasurer

Dept.. of Treasurer

Dividend Payout Ratio

Annual dividend

Net income

The % of

earnings paid

as dividends


Allocation of cash dividends

1998

1

2

3

1999

4

5

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Allocation of Cash Dividends

1) Distribute dividends in arrears, if any, to preferred

2) Distribute current dividends to preferred

3) Distribute remainder to common (or to both if preferred is participating)


Cash dividends example

Cash Dividends Example

Stricker Company declares a $70,000 dividend for 2004 (no dividends were paid in 2002 or 2003).

There are 10,000 shares of $10 par, 8% preferred stock and 40,000 shares of $5 par common stock outstanding.


Cash dividends example1

Cash Dividends Example

Noncumulative Preferred Stock

PreferredCommon

Step 1: Distribute current-year dividend to

preferred (10,000 shares x $10 par x 8% x 1 yr.) $8,000

Step 2: Distribute remaining dividend to common

($70,000 - $8,000) $62,000

Total allocated $8,000 $62,000

$0.80

per share

$1.55

per share


Cash dividends example2

Cash Dividends Example

Cumulative Preferred Stock

PreferredCommon

Step 1: Distribute dividends in arrears to

preferred (10,000 shares x $10 par x 8% x 2 yrs.)$16,000

Step 2: Distribute current-year dividend to

preferred (10,000 shares x $10 par x 8% x 1 yr.) 8,000

Step 3: Distribute remaining dividend to common

($70,000 - $24,000) $46,000

Total allocated$24,000 $46,000

$2.40

per share

$1.15

per share


Cash dividends example3

Cash Dividends Example

Cumulative and Participating Preferred Stock

PreferredCommon

Step 1: Distribute dividend in arrears to

preferred (10,000 shares x $10 x 8% x 2 yrs.)$16,000

Step 2: Distribute current-year dividend to

preferred (10,000 shares x $10 par x 8% x 1 yr.) 8,000

Step 3: Distribute equal percentage to common

(40,000 shares x $5 x 8%) $16,000

Step 4: Remainder to preferred and common on

basis of total par value 10,000 20,000

Total allocated$34,000 $36,000

$3.40

per share

$0.90

per share


Stock dividends

Certificate of Stock

Certificate of Stock

Certificate of Stock

Certificate of Stock

Certificate of Stock

Certificate of Stock

Stock Dividends

  • Issue of additional shares proportionately to existing stockholders

  • Reasons:

    • insufficient cash

    • market price reduction

    • nontaxable to recipients


Small stock dividend example

Small Stock Dividend Example

Stockholders’ Equity:

Common stock, $10 par,

5,000 shares $ 50,000

Additional paid-in cap. 30,000

Retained earnings 70,000

Total $150,000

Before

Dividend

Assume Shah Company declares 10% stock dividend;

500 shares @ $40 per share market value


Small stock dividend example1

Small Stock Dividend Example

Stockholders’ Equity:

Common stock, $10 par,

5,500 shares$ 50,000$ 55,000

Additional paid-in cap. 30,000 45,000

Retained earnings 70,000 50,000

Total$ 150,000$150,000

BeforeAfter

+

+

-

$40 market value deducted from retained earnings; allocated between Common Stock (initially Common Stock Dividend Distributable) and Additional Paid-In Capital.


Small stock dividend example2

Small Stock Dividend Example

BeforeAfter

Stockholders’ Equity:

Common stock, $10 par,

5,500 shares$ 50,000$ 55,000

Additional paid-in cap. 30,000 45,000

Retained earnings 70,000 50,000

Total$ 150,000$150,000

+

+

-

Total S/E is unchanged


Large stock dividend example

Large Stock Dividend Example

Stockholders’ Equity:

Common stock, $10 par,

5,000 shares $ 50,000

Additional paid-in cap. 30,000

Retained earnings 70,000

Total $150,000

Before

Dividend

Assume Shah Company declares 100% stock dividend


Large stock dividend example1

Large Stock Dividend Example

Stockholders’ Equity:

Common stock, $10 par,

10,000 shares$ 50,000$100,000

Additional paid-in cap. 30,000 30,000

Retained earnings 70,00020,000

Total$ 150,000$150,000

BeforeAfter

+

-

Dividend deducted from retained earnings and recorded in the Common Stock account at par. Additional Paid-In Capital account is unaffected.


Large stock dividend example2

Total S/E is unchanged

Large Stock Dividend Example

Stockholders’ Equity:

Common stock, $10 par,

10,000 shares$ 50,000$100,000

Additional paid-in cap. 30,000 30,000

Retained earnings 70,000 20,000

Total$ 150,000$150,000

BeforeAfter

+

-


Stock splits

Certificate of Stock

Certificate of Stock

$3 par value

Certificate of Stock

Certificate of Stock

$1 par value

Stock Splits

  • Results in additional issuance of shares

  • Reduces par value per share

  • No change in Stockholders’ Equity accounts


Stock splits1

Disclose

in notes

Stock Splits

  • Not recorded in accounts

  • Splits reduce market value per share and make stock more affordable to a wider range of investors


2 for 1 stock split example

2-for-1 Stock Split Example

Before

Split

Stockholders’ Equity:

Common stock, $10 par,

5,000 shares$ 50,000

Additional paid-in cap. 30,000

Retained earnings 70,000

Total$ 150,000

Assume Shah Company declares 2-for-1 stock split.


2 for 1 stock split example1

Only disclosures are affected

All accounts are unchanged

2-for-1 Stock Split Example

Stockholders’ Equity:

Common stock, $5.00 par,

10,000 shares$ 50,000$ 50,000

Additional paid-in cap. 30,000 30,000

Retained earnings 70,000 70,000

Total$ 150,000$150,000

BeforeAfter


Statement of stockholders equity

Statement of Retained Earnings

Beginning retained earnings

Add: Net income

Subtract: Dividends

= Ending retained earnings

Statement of Stockholders’ Equity

  • Shows changes in all equity accounts including

    • Sales and Purchases of capital stock

  • Includes:


Statement of comprehensive income

Statement of Comprehensive Income

Income Statement

For Year Ended Dec. 31, 20xx

Revenues xxx

Expenses xxx

Other gains and losses xxx

Income before tax xxx

Income tax expense xxx

Net income xxx

Statement of Comprehensive Income

For Year Ended Dec. 31, 20xx

Net incomexxx

Foreign currency translation adjustmentxxx

Unrealized holding gains/lossesxxx

Minimum pension liability adjustmentxxx

Other comprehensive incomexxx

Comprehensive incomexxx

Comprehensive income – the total change in net assets from all sources except investments by or distributions to the owners


Analyzing owners equity

Analyzing Owners’ Equity

  • Book value per share

    • rights of each share to net assets of corporation

  • Market value per share

    • price at which stock is currently selling


Book value per share

Book Value per Share

Total Common Stockholders’ Equity

# of Common Shares Outstanding

  • Rights of common stockholders in event of liquidation

  • Generally represents “floor” price of stock


Book value vs market value

Book Value vs. Market Value

From Delta's 2001 annual report:

Book value per share:$26.91

Market value per share

in 2001: $38.24 (avg.)

Which value would you expect to pay for a share of Wrigley stock?

What factors account for the difference between the two values?


Stockholders equity items on the statement of cash flows

Stockholders’ Equity Items on the Statement of Cash Flows

Operating Activities

Net income xxx

Investing Activities

Financing Activities

Issuance of stock +

Retirement or repurchase

of stock -

Payment of dividends -

46


Appendix

Appendix

Accounting Tools:

Unincorporated Businesses


Sole proprietorships

Sole Proprietorships

  • Not a separate legal entity so owner has unlimited liability

  • Must keep personal and business records separate

  • Business income is declared on the owner’s personal tax return and taxed at personal tax rate


Sole proprietorships1

Sole Proprietorships

Owner’s withdrawal of assets from business:

Peter Tom, Drawing6,000

Equipment 6,000

Owners’ drawing or withdrawal accounts are contra-equity accounts


Sole proprietorships2

Sole Proprietorships

  • Drawing or withdrawal and income summary accounts are closed to the owner’s capital account

  • Owner’s Equity section of the balance sheet consists of the capital account:

Beginning balance$ 0

Plus: Investments 10,000

Net Income 4,000

Less: Withdrawals (6,000)

Ending balance $ 8,000


Partnerships

Partnerships

  • Unlimited liability

  • Limited life – partnership agreements can and do end

  • Not taxed as a separate entity


Partnerships1

Partnerships

Distribution of income:

  • Equal distribution

  • Stated ratio

  • Other allocation

    • For example, based on salaries, interest on invested capital, and a stated ratio


End of chapter 11

Certificate of Stock

End of Chapter 11


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