Understanding Shareholders' Equity in Financial Reporting

1. Shareholders’ Equity Chapter 18

2. Assets – Liabilities = Shareholders’ Equity The Nature of Shareholders’ Equity Net Assets Sources ofShareholders’Equity Amounts earnedby corporation Amounts investedby shareholders Shareholders’ Equity Other gains and losses not included in net income Paid-in Capital Retained Earnings Accumulated OtherComprehensive Income

3. Financial Reporting Overview

4. Gains (losses) from and amendments to postretirement benefit plans. Gains (losses) from foreign currency translations. Accumulated OtherComprehensive Income Accumulated other comprehensive income includes four types of gains and losses not included in net income. Deferred gains (losses) from derivatives. Net holding gains (losses) on investments.

5. There are 2 options for reporting comprehensive income created during the reporting period. The accumulated amount of comprehensive income is reported as a separate item of shareholders’ equity in the balance sheet. As an additional section of the income statement. As a separate statement immediately following the income statement Accumulated OtherComprehensive Income Comprehensive income is reported periodically as it is created and also is reported as a cumulative amount.

6. U.S. GAAP vs. IFRS Terminology Differences Capital stock: Common stock. Preferred stock. Paid‐in capital—excess ofpar, common. Paid‐in capital—excess ofpar, preferred. Share capital: • Ordinary shares. • Preference shares. • Share premium, ordinaryshares. • Share premium, preference shares.

7. U.S. GAAP vs. IFRS Terminology Differences Accumulated other comprehensive income: Net gains (losses) on investment ―AOCI. Net gains (losses) foreign currency translation —AOCI. Fair value adjustments not permitted. Retained earnings. Total shareholders’ equity. Presented after liabilities • Reserves: • Investment revaluation reserve. • Translation reserve. • Revaluation reserve. • Retained earnings. • Total equity. • Often presented before liabilities.

8. The Corporate Organization Advantages of a corporation Easy ownership transfer Easy toraise capital Continuousexistence Limitedliability Governmentregulation Disadvantages of a corporation Doubletaxation

9. Not-for-profitcorporations includehospitals, charities, and governmentagencies such as FDIC. Publicly-heldcorporationswhose shares are widelyowned by the general public. Privately-heldcorporationswhose shares are owned by only a few individuals. Types of Corporations

10. SCorporation Limited liability protection of a corporation. Maximum number of owners. Limited liabilitycompany 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. Hybrid Organizations Doubletaxationavoided.

11. The Model Business Corporation Act • Nature and location of business activities. • Number and classes of shares authorized. Corporate Charter 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.

12. Fundamental Share Rights Right to vote. Preemptiveright to maintainpercentageownership. Right to sharein profits when dividends aredeclared. Right to sharein distribution ofassets if companyis liquidated.

13. Authorized, Issued, andOutstanding Shares Authorized shares are the maximumnumber of shares of capital stock thatcan be sold to the public. Issued shares are authorized shares of stock that have been sold. Unissued shares are authorized shares of stock that never have been sold.

14. Outstanding sharesare issued shares that are owned by stockholders. Issued Shares Treasury sharesare issued shares that have been reacquired by the corporation. Authorized, Issued, andOutstanding Shares Authorized Shares Outstanding Shares Unissued Shares Treasury Shares Retired shareshave the same status as authorized but unissued shares. Retired Shares

15. Par value stock Dollar amount per share is stated in the corporate charter. Par value has no relationship to market value. No-par stock Dollar amount per share is not designated in corporate charter. Corporations can assign a stated value per share (treated as if par value). Capital Stock • Legal capital is . . . • The portion of shareholders’ equity that must be contributed to the firm when stock is issued. • The amount of capital, required by state law, that must remain invested in the business. • Refers to par value, stated value, or full amount paid for no-par stock.

16. Capital Stock Common stock is the basic voting stock of the corporation. It ranks after preferred stock for dividend and liquidation distribution. Dividends are determined by the board of directors. Usually has apar or stated value. Generally does nothave voting rights. PreferredStock Dividend and liquidation preference overcommon stock. May be convertible,callable, and/orredeemable.

17. 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. Unpaid dividends must be paid in full before any distributions to common stock. Dividends in arrearsare not liabilities, but the per share and aggregate amounts must be disclosed.

18. U.S. GAAP vs. IFRS Distinction between Debt and Equityfor Preferred Stock Preferred stock normally is reported as equity, but is reported as debt with the dividends reported in the income statement as interest expense if it is “mandatorily redeemable” preferred stock. • Most non-mandatorily redeemable preferred stock (preference shares) also is reported as debt as well as some preference shares that aren’t redeemable. Under IFRS (IAS No. 32), the critical feature that distinguishes a liability is if the issuer is or can be required to deliver cash (or another financial instrument) to the holder.

19. Shares Issued for Cash 10,000 shares of stock are issued for $100,000 cash. Cash ....................................................... 100,000 Common stock, par value .............. 10,000 Paid-in capital – excess of par …… 90,000 To record issue of common stock. $1 Par Value Cash ....................................................... 100,000 Common stock ............................. 100,000 To record issue of common stock. No ParValue No Par,$1 Stated Value Cash ................................................................... 100,000 Common stock, stated value ..................... 10,000 Paid-in capital – excess of stated value …. 90,000 To record issue of common stock.

20. Apply the general valuation principle by using fair value of stock given up or fair value of asset received, whichever is more clearly evident. If market values cannot be determined, use appraised values. Shares Issued forNoncash Consideration

21. Allocate the lump-sum received based on the relative fair values of the two securities. If only one fair value is known, allocate a portion of the lump-sum received based on that fair value and allocate the remainder to the other security. More Than One SecurityIssued for a Single Price Toys Inc. issued 5,000 shares of common stock, $10 par value, and 3,000 shares of preferred stock, $5 par value, for $450,000. The market values of the common stock andpreferred stock were $55 and $75, respectively. Calculate the additional paid-incapital for each class of stock.

22. More Than One SecurityIssued for a Single Price Cash ............................................................................ 450,000 Common stock, $10 par ..................................... 50,000 Paid-in capital – excess of par common ……….. 197,500 Preferred stock, $5 par 15,000 Paid-in capital – excess of par preferred ………. 187,500 To record issue of common and preferred stock.

23. 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.

24. 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. Share Buybacks Companies can account for the reacquired shares by retiring them or by holding them as treasury shares.

25. 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. • Price paid isless than issue price. 5,000 shares of $2 par value stock that were issuedfor $20 per share are reacquired for $17 per share. Common stock ............................................................ 10,000 Paid-in capital – excess of par common …………….... 90,000 Paid-in capital – share repurchase …………….. 15,000 Cash ……………………………………………….. 85,000 To record repurchase and retirement of common stock.

26. Reduce Retained Earnings if the Paid-in capital—share repurchase account balance is insufficient. Accounting for Retired Shares • Price paid is more than issue price. 5,000 shares of $2 par value stock that were issuedfor $20 per share are reacquired for $25 per share. Common stock ............................................................ 10,000 Paid-in capital – excess of par common ………………. 90,000 Paid-in capital – share repurchase …………………….. 25,000 Cash ……………………………………………….. 125,000 To record repurchase and retirement of common stock.

27. Accounting for Treasury Stock • Treasury stock usually does not have: • Voting rights. • Dividend rights. • Preemptive rights. • Liquidation rights. • Treasury stock is reported as an unallocated reductionof total Shareholders’ Equity. • Acquisition of Treasury Stock • Recorded at cost to acquire. • Resale of Treasury Stock • Treasury Stock credited for cost. • Difference between cost and issuance price is (generally) recorded in paid-in capital—share repurchase.

28. On 5/1/12, Photos-in-a-Second reacquired 3,000 shares of its common stock at $55 per share. On 12/3/13, Photos-in-a-Second reissued 1,000 shares of the stock at $75 per share. Which of the following would be included in the 12/3/13 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. Accounting for Treasury Stock May 1, 2012: Treasury stock .............................................. 165,000 Cash ................................................... 165,000 To record purchase of treasury stock. December 3, 2013: Cash ............................................................. 75,000 Treasury stock .................................... 55,000 Paid-in capital – share repurchase …. 20,000 To record reissue of treasury stock.

29. Where We’re Headed The FASB and IASB are working to establish a common standard for presenting information in the financial statements, An important part of the proposal involves the organization of elements of the balance sheet, statement of comprehensive income, and statement of cash flows into a common set of classifications. A key feature of the new format is that each of the financial statements will include classifications by operating, investing, and financing activities (similar to the current statement of cash flows). Operating and investing activities will be included within a new category, “business” activities. Each statement also will include three additional groupings: discontinued operations, income taxes, and multi-category transactions (if needed).

30. Represents the undistributed earnings of the company since its inception. Retained Earnings • The statement of retained earnings may also contain the correction of an accounting error that occurred in the financial statements of a prior period, called a prior period adjustment. • Any restrictions on retained earnings must be disclosed in the notes to the financial statements.

31. Accounting for Cash Dividends Declared by board of directors. Not legally required. Requires sufficient Retained Earnings and Cash. Creates liability at declaration. Declaration date • Board of directors declares a $10,000 cash dividend. • Record a liability. Declaration Date: Retained earnings ........................................ 10,000 Dividends payable .............................. 10,000 To record declaration of cash dividend.

32. Dividend Dates Ex-dividend date The first day the shares trade without the right to receive the declared dividend. (No entry) Date of Record Stockholders holding shares on this date will receivethe dividend. (No entry) Date of Payment Record the dividend payment to stockholders. Date of Payment: Dividends payable ........................................ 10,000 Cash ……………….............................. 10,000 To record payment of cash dividend.

33. Distributions of non-cash assets. Record at fair valueof noncash asset. Recognizegain or lossfor difference between book value and fair value. Property Dividends

34. Record at current fairvalue of stock. Record at parvalue of stock. Accounting for Stock Dividends Distribution of additional shares of stock to owners. No change in total stockholders’ equity. No change inpar values. All stockholders retain same percentage ownership. Small Large Stock dividend > 25% Stock dividend < 25%

35. CarCo declares and distributes a 20% stock dividend on 5 million common shares. Par value is $1 and market value is $20. The required journal entry would be: Accounting for Stock Dividends Retained earnings ..................................................... 20,000,000 Common stock …………………………………. 1,000,000 Paid-in capital – excess of par common …….. 19,000,000 To record declaration and distribution of small stock dividend. 5,000,000 shares × 20 % = 1,000,000 shares issued × $20 = $20,000,000

36. Stock Splits Stock splits change the par value per share and the number of shares outstanding, but the total par value is unchanged, and no journal entry is required. Assume that a corporation had 3,000 shares of $2 par value common stock outstanding before a 2–for–1 stock split. Increase Decrease No Change

37. Stock Splits Effected in theForm of Large Stock Dividends Matrix Inc. declares and distributes a 2-for-1 stock split effected in the form of a 100% stock dividend. The company has 1,000,000, $1 par value common stock outstanding. The stock is trading in the open market for $14 per share. The per share par value of the shares is notto be changed. Paid-in capital – excess of par common …................. 1,000,000 Common stock ……………..……………………. 1,000,000 To record declaration and distribution of 2-for-1 stocksplit effected in the form of a 100% stock dividend.

38. Appendix 18 ─ Quasi Reorganizations Purpose To allow a company undergoing financial difficulty, but with favorable future prospects, to get a fresh start by writing down inflated assets and eliminating an accumulated balance in retained earnings. • Procedures • Assets and liabilities are revalued to reflect market values, with corresponding debits and credits to retained earnings. • The debit balance in retained earnings is eliminated first against additional paid-in capital, and then, if necessary, against common stock. • Retained earnings is dated to indicate when the new accumulation of earnings began.

39. Quasi Reorganizations Emerson-Walsch Corporation has incurred losses for several years. The board of directors voted to implement a quasi reorganization, subject to shareholder approval. The balance sheet prior to restatement, in millions, follows : Fair values: Inventory = $300,000,000 and Property, plant, and equipment = $225,000,000. Let’s prepare the journal entries necessary for the quasi reorganization.

40. Quasi Reorganizations To revalue assets Retained earnings ………………………….................. 250,000,000 Inventory …………………………………………. 75,000,000 Property, plant, & equipment …………………… 175,000,000 To record reduction to fair value of assets. To eliminate the deficit in retained earnings Paid-in capital – excess of par common …….............. 150,000,000 Common stock ………….………………………………. 400,000,000 Retained earnings ………………..……………… 550,000,000 To eliminate the deficit in retained earnings. $300,000,000 + $250,000,000

41. Quasi Reorganizations Balance sheet immediately after restatement.

42. End of Chapter 18