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Stockholders’ Equity. Chapter 8. Learning Objectives. Account for the issuance of capital stock. Describe a compensatory stock option plan. Account for share appreciation rights . Describe the characteristics of preferred stock. Know the components of contributed capital .

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Chapter 8

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Chapter 8

Stockholders’ Equity

Chapter 8


Learning objectives

Learning Objectives

  • Account for the issuance of capital stock.

  • Describe a compensatory stock option plan.

  • Account for share appreciation rights.

  • Describe the characteristics of preferred stock.

  • Know the components of contributed capital.

  • Understand the accounting for treasury stock.

  • Recognize compensation expense for a compensatory stock option plan using the fair value method. Account for a fixed compensatory stock option plan.

  • Account for a performance-based compensatory stock option plan.


Chapter 8

Owners’or Stockholders’Equity

  • Represents the owners’ residual interest in total assets after liabilities are recognized.

  • Difference between the assets and the liabilities of a company.

  • Is sometimes referred to as net assets.


Chapter 8

Formation of a Corporation

  • State laws dictate the incorporation process.

  • Articles of incorporation are filed with the state.

    -- Specify the purpose of the business, its location, classes and number of shares of capital stock authorized, etc.

  • The state issues a corporate charter.

  • A board of directors is selected.


Chapter 8

Classifications of Corporations

  • Public corporations

    -- Government-owned: FDIC, TVA

  • Private corporations

    -- Nonstock corporations

    • Nonprofit organizations that do not issue stock: churches, colleges, charities

      -- Stock corporations

    • Closed corporations: few stockholders

    • Open corporations: publicly traded


Chapter 8

Characteristics of Capital Stock

Ownership of common stock usually entitles the holder to the . . .

  • Right to vote.

  • Right to participate in earnings through declared dividends.

  • Right to participate in distribution of assets at liquidation.

  • Right to retain percentage of ownership in the corporation when new shares are issued (preemptive right).


Chapter 8

Concepts and Definitions

  • Corporations are a separate legal entity.

  • Issues of stock are recorded in conformity with the cost principle.

  • Sales and repurchases of shares do not affect periodic net income.

  • Stockholders’equity is separated from debt of the entity.


Chapter 8

Concepts and Definitions

  • Categories of equity

    -- Contributed capital (Paid-in capital)

    • Capital Stock: Preferred and Common

    • Additional paid-in capital

      -- Retained earnings

    • Unappropriated and appropriated

      -- Unrealized capital

    • Increases or decreases in equity that donot result from stock transactions or from the retention of retained earnings.


Chapter 8

Concepts and Definitions

Classification of capital stock

  • Authorized

  • Issued

  • Unissued

  • Treasury stock

  • Outstanding

  • Subscribed


Chapter 8

Authorized, Issued, and Outstanding Capital Stock

Authorized

Shares

The maximum number of shares of capital stock that can be sold to the public is called the authorized number of shares.


Chapter 8

Authorized, Issued, and Outstanding Capital Stock

Authorized

Shares

Issued shares are authorized shares of stock that have been sold.

Unissued shares are authorized shares of stock that have never been sold.


Chapter 8

Authorized, Issued, and Outstanding Capital Stock

Outstanding shares are issued shares that are owned by stockholders.

Authorized

Shares

Outstanding

Shares

Unissued

Shares

Issued

Shares

Treasury shares are issued shares that have been reacquired by the corporation.

Treasury

Shares


Chapter 8

Corporations

  • Advantages

    -- Limited liability

    -- Capital accumulation

    -- Ease of ownership transfer

  • Disadvantages

    -- Increased taxation

    -- Difficulties of control

    -- Regulation


Chapter 8

Features of Equity Securities

  • Par value stock

    -- Designated dollar amount per share stated in the corporate charter.

    -- No relationship to market value.

  • Nopar stock

    -- Dollar amount per share not designated in corporate charter.

    -- Corporations can assign a stated valueper share (treated as if par value).


Chapter 8

Features of Equity Securities

Legal capital is . . .

-- That portion of stockholders’equity that must be contributed to the firm at the issuance of stock.

-- 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 nopar stock.


Chapter 8

Features of Equity Securities

Common stock . . .

-- Is the basic voting stock of the corporation.

-- Ranks after preferred stock for dividend and liquidation distribution.

-- Has dividend rates determined by the board of directors based on the corporation’s profitability.


Chapter 8

Features of Equity Securities

Preferred stock . . .

-- Has dividend and liquidation preference over common stock.

-- Generally does not have voting rights.

-- Usually has a par or stated value.

-- May be convertible, callable, and/or redeemable.


Chapter 8

Features of Equity Securities

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.


Chapter 8

Preferred StockCumulative Dividends

  • Provides that dividends not declared in previous years accumulate and must be paid in full when dividends are declared in later years before dividends can be paid on common stock.

  • Dividends in arrearsare not liabilities until declared. However, the per share and aggregate amounts must be disclosed.


Chapter 8

Preferred Stock Example

Kites, Inc. has the following stock outstanding:

Common, $1 par value, 100,000 shares

Preferred, 3%, $100 par value, cumulative, 5,000 shares

Preferred, 6%, $50 par value, noncumulative, 3,000 shares

Dividends were paid every year except for the prior year. In the current year the board of directors declares dividends of $50,000.

How much in dividends does each class of stock receive?


Chapter 8

Preferred Stock Example


Chapter 8

Preferred Stock Example


Chapter 8

Preferred Stock Example


Chapter 8

Preferred Stock Participating Preferences

  • Nonparticipating

    Limits the yearly dividends to the specified rate plus

    any arrearage for cumulative stock.

  • Partially participating

    Allows dividends above the specified rate on a pro

    rata basis with common stock up to a limit specified

    in the corporate charter.


Chapter 8

Preferred Stock Participating Preferences

  • Fully participating

    Allows dividends above the specified rate on a pro

    rata basis with common stock without any limits.


Chapter 8

Preferred Stock Example

Kites, Inc. has the following stock outstanding:

Common, $1 par value, 100,000 shares

Preferred, 3%, $100 par value, noncumulative, 5,000 shares

Dividends were paid every year except for the prior year.

The preferred is partially participating up to 5%. In the

current year the board of directors declares dividends of

$60,000. How much in dividends does each class of stock

receive?


Chapter 8

Preferred Stock Example


Chapter 8

Preferred Stock Example


Chapter 8

Preferred Stock Example


Chapter 8

Issuing Stock for Cash

Par value stock:

Cash (DEBIT)

Common Stock, par value(CREDIT)

Additional Paid-in Capital, Common Stock (CREDIT)

In this entry, Common Stock is credited for the par value of the stock issued. The excess over par is credited to the Contributed Capital in Excess of Par account.


Chapter 8

Issuing Stock for Cash

Nopar stock:

Cash (DEBIT)

Common Stock (CREDIT)

Stated value stock:

Cash (DEBIT)

Common Stock, stated value (CREDIT)

Additional Paid-in Capital, Common Stock (CREDIT)

In this entry, Common Stock is credited for the stated value of the stock issued. The excess over stated value is credited to the Contributed Capital in Excess of Stated Value account.


Chapter 8

Stock Subscriptions

A corporation enters into a subscription contract with several subscribers that calls for the purchase of 1,000 shares of $6 par common stock at a price of $13 per share. A $3 per share down payment is required, with the remaining $10 due in one month.

Cash3,000

Subscription Receivable: Common

Stock10,000

Common Stock Subscribed6,000

Additional Paid-in Capital on

Common Stock7,000

$6 x 1,000


Chapter 8

Stock Subscriptions

The $10 per share final payment was received from subscribers to 950 of the 1,000 shares.

Cash9,500

Subscription Receivable:

Common Stock9,500

Common Stock Subscribed5,700

Common Stock, $6 par5,700

950 x $6


Chapter 8

Stock Subscriptions

When a default occurs, the accounting is determined by the relevant contract provisions, such as--

  • Return to the subscriber the entire amount paid in.

  • Return to the subscriber the entire amount paid in, less any costs incurred to reissue the stock.

  • Issue to the subscriber a lesser number of shares based upon the total amount of payment received.

  • Require the forfeiture of all amounts paid in.


Chapter 8

Stock Subscriptions

The subscriber to the 50 remaining shares defaults on the contract. The contract requires the forfeiture of all amounts paid in.

Common Stock Subscribed300

Additional Paid-in Capital on Common

Stock350

Subscription Receivable:

Common Stock500

Additional Paid-in Capital from

Subscription Default150

50 X $6

50 X $7

50 X $10


Chapter 8

Issuing Stockfor Noncash Assets

  • Use the current market value of the stock issued or the noncash consideration received, whichever is most reliably determinable.

  • If market values cannot be determined, use appraised values.


Chapter 8

Combined Sales of Stock

Total proceeds must be allocated among the classes of stock issued:

  • Proportional method

    Allocate the lump-sum received among the classes of stock issued based on their relative market values.

  • Incremental method

    Allocate a portion of the lump-sum received to one security based on that security’s market value and allocate the remainder to the other security.


Chapter 8

Combined Sales of StockExample

A corporation issues 100 packages of securities for $82.80 per package. Each package consists of two shares of $10 par common stock (market value, $16 per share) and one share of $50 par preferred stock (market value, $60 per share).

Common Stock: $16 x 2 shares x 100= $ 3,200

Preferred Stock: $60 x 1 share x 100= 6,000

Total market value$9,200


Chapter 8

$3,200

$9,200

Common Stock: x $8,280 = $2,880

$6,000

$9,200

Preferred Stock: x $8,280 = 5,400

$8,280

Combined Sales of StockExample

A corporation issues 100 packages of securities for $82.80 per package. Each package consists of two shares of $10 par common stock (market value, $16 per share) and one share of $50 par preferred stock (market value, $60 per share).


Chapter 8

Combined Sales of StockExample

A corporation issues 100 packages of securities for $82.80 per package. Each package consists of two shares of $10 par common stock (market value, $16 per share) and one share of $50 par preferred stock (market value, $60 per share).

Cash8,280

Common Stock2,000Additional Paid-in Capital on Com. Stock880

Preferred Stock, $50 par5,000

Additional Paid-in Capital on Pref. Stock400


Chapter 8

Stock Issue Costs

Costs incurred to issue stock

  • Registration fees

  • Underwriter commissions

  • Attorney and accountant fees

  • Printing costs

  • Clerical costs

  • Promotional costs


Chapter 8

Stock Issue Costs

Two methods of accounting for stock issue costs:

Offset method

Debit costs to Contributed Capital in Excess of Par.

Deferred charge method

Debit an intangible asset and amortize over a reasonable

period.


Chapter 8

Stock Issuance Costs

The FASB is planning to change GAAP so that all stock issuance costs are expensed as incurred.


Chapter 8

Unrealized Capital

Represents an increase or decrease in stockholders’equity not arising from earnings, dividend payments, or a change in contributed capital. Examples include:

  • Unrealized holding gains and losses on available for sale securities.

  • Gains and losses resulting from translating foreign-denominated financial statements into US currency.

  • Guarantees of ESOP debt.

  • Pension liability adjustments.


Chapter 8

Any questions?


Chapter 8

Treasury Stock

Repurchased shares of a corporation’s own stock

The shares are retired or used to:

  • Issue in employee stock option programs.

  • Establish a market for the company’s stock.

  • Purchase assets.

  • Issue as a stock dividend.

  • Increase earnings per share.

  • Reduce ownership.

  • Thwart takeover attempts.

  • Reduce dividend payments.


Chapter 8

Treasury StockCharacteristics

  • Usually does not have:

    -- Voting rights

    -- Dividends rights

    -- Preemptive rights

    -- Liquidation rights

  • Reduces both assets and stockholders’ equity

  • Is classified as a contra account to stockholders’ equity


Chapter 8

Treasury StockRecording and Reporting

Cost method

(one-transaction concept)

Par value method

(dual-transaction concept)


Chapter 8

Treasury StockCost Method

The purchase and subsequent sale of treasury stock are viewed as one transaction with two parts.


Chapter 8

Treasury StockCost Method

  • Acquisition of Treasury Stock

    -- Recorded at cost to acquire.

    Treasury Stock (DEBIT)

    Cash (CREDIT)

  • Issuance of Treasury Stock

    -- Treasury Stock credited for cost.

    -- Difference between cost and issuance price is (generally) recorded in Additional Paid-in Capital-Treasury Stock.


Chapter 8

Treasury Stock

Cost Method

Ball issues 6,000 shares of $10 par common stock for $12 per share:

Cash72,000

Common Stock $10 par60,000

Additional Paid-in Capital on

Common Stock12,000


Chapter 8

Treasury Stock

Cost Method

Reacquisition of 1,000 shares of common stock at $13 per share:

Treasury Stock13,000

Cash13,000


Chapter 8

Treasury Stock

Cost Method

Reissuance of 600 shares of treasury stock at $15 per share:

Cash9,000

Treasury Stock7,800

Additional Paid-in Capital from

Treasury Stock1,200


Chapter 8

Treasury Stock

Cost Method

Reissuance of another 200 shares of treasury stock at $8 per share:

Cash1,600

Additional Paid-in Capital from

Treasury Stock1,000

Treasury Stock2,600


Chapter 8

Treasury Stock

Cost Method

Reissuance of another 100 shares of treasury stock at $10 per share:

Cash1,000

Additional Paid-in Capital from

Treasury Stock200

Retained Earnings100

Treasury Stock1,300


Chapter 8

Treasury StockPar Value Method

Date of acquisition

  • Debit Treasury Stock for the par value, stated value, or average amount previously credited to the capital stock account for nopar stock.

  • Debit Additional Paid-in Capital for the proportionate amount of any excess over par or stated value that was paid by stockholders when the shares were originally issued.

  • Debit or credit Additional Paid-in Capital from Treasury Stock as required.

    -- Debit cannot exceed the credit balance in the account. Any excess is debited to Retained Earnings.

  • Credit Cash.


Chapter 8

Treasury StockPar Value Method

Date of resale

  • Debit Cash.

  • Credit Treasury Stock for the par value, stated value, or average amount previously credited to the capital stock account for nopar stock.

  • Credit Additional Paid-in Capital fromTreasury Stock or debit Additional Paid-in Capital from Treasury Stock (and Retained Earnings, if necessary).


Chapter 8

Treasury Stock

Par Value Method

Issuance of 6,000 shares of $10 par common stock for $12 per share:

Cash72,000

Common Stock $10 par60,000

Additional Paid-in Capital on

Common Stock12,000


Chapter 8

Treasury Stock

Par Value Method

Reacquisition of 1,000 shares of common stock at $13 per share:

Treasury Stock10,000

Additional Paid-in Capital on

Common Stock2,000

Retained Earnings1,000

Cash13,000


Chapter 8

Treasury Stock

Par Value Method

Reissuance of 600 shares of treasury stock at $15 per share:

Cash9,000

Treasury Stock6,000

Additional Paid-in Capital on

Common Stock3,000


Chapter 8

Treasury Stock

Par Value Method

Reissuance of another 200 shares of treasury stock at $8 per share:

Cash1,600

Additional Paid-in Capital on

Common Stock400

Treasury Stock2,000


Chapter 8

Treasury Stock

Par Value Method

Reissuance of another 100 shares of treasury stock at $10 per share:

Cash1,000

Treasury Stock1,000


Chapter 8

Treasury Stock

Cost Method

Contributed Capital:

Common stock, $10 par (20,000 shares authorized,

6,000 shares issued , of which 100 are being held

in treasury)$ 60,000

Additional paid-in capital on common stock 12,000

Total contributed capital$ 72,000

Retained earnings39,900

Accumulated other comprehensive income 10,000

Total contributed capital, retained earnings, and$121,900

accumulated other comprehensive income

Less: Treasury stock (100 shares at cost) (1,300)

Total Stockholders’ Equity$120,600


Chapter 8

Treasury Stock

Par Value Method

Contributed Capital:

Common stock, $10 par (20,000 shares authorized,

6,000 shares issued)$ 60,000

Less: Treasury stock (100 shares at par) (1,000)

Common stock outstanding (5,900 shares)$ 59,000

Additional paid-in capital on common stock 12,600

Total paid-in capital$ 71,600

Retained earnings39,000

Accumulated other comprehensive income 10,000

Total Stockholders’ Equity$120,600


Chapter 8

Stock Received by Donation

When stockholders donate shares to the corporation, the corporation debits Treasury Stock and credits a revenue or gain account.


Chapter 8

Retirement of Treasury Stock

When treasury shares are formally retired, the corporation credits the Treasury Stock account and debits all capital accounts related to the treasury shares on a proportional basis.


Chapter 8

Convertible Preferred Stock

  • Provides stockholders an option to exchange their shares, within a specified time period, for other classes of stock, usually common stock, at a specified rate.

  • Accounting treatment is the same as convertible bonds.


Chapter 8

Convertible Preferred Stock

Ness Corporation originally issued 500 shares of $100 par convertible preferred stock at $120 per share. Each share of preferred stock may be converted into four shares of $20 par common stock.

Preferred Stock, $100 par50,000

Additional Paid-in Capital on Preferred

Stock10,000

Common Stock, $20 par40,000

Additional Paid-in Capital from

Preferred Stock Conversion20,000

Continued


Chapter 8

Convertible Preferred Stock

Alternatively, assume each preferred share may be converted into seven shares of common stock.

Preferred Stock, $100 par50,000

Additional Paid-in Capital on Preferred

Stock10,000

Retained Earnings10,000

Common Stock, $20 par70,000


Chapter 8

Stock Rights

  • Rights issued by the corporation that give the holder an option to acquire a specified number of shares of capital stock under prescribed conditions within a stated period of time.The document of ownership is called a stock warrant.

  • Normally arise:

    • As compensation to employees

    • As compensation to employees

    • As fractional share rights

    • To make a security more attractive


Chapter 8

Stock RightsImportant Dates

  • Announcement date of the rights offering

  • Issuance date of the rights

  • Expiration date of the rights

  • Between the issuance date and the expiration date, the rights and the related stock are sold separately and each have a separate price.


Chapter 8

Stock RightsPreemptive Rights

  • Stock rights issued to existing shareholders in advance of a new stock issuance.

  • No entries required on announcement date or on issuance date of the rights.

  • On exercise date

    • debit Cash.

    • credit Capital Stock and Additional Paid-in Capital.


Chapter 8

Stock Compensation Plans

  • Used to

    -- recruit and retain outstanding employees.

    -- encourage employee ownership.

    -- obtain additional capital from equity owners.

  • Most critical accounting issue is whether the program causes additional expenses for the corporation (or grantor).


Chapter 8

Stock Compensation Plans

New FASB standard requires companies to recognize compensation cost using the fair-value method.*

Under fair-value method, companies use acceptable option-pricing models to value the options at the date of grant.

*“Accounting for Stock-Based Compensation,”Statement of Financial Accounting Standards No. 123 (Norwalk, Conn: FASB, 1995); and “Share-Based Payment,”Statement of Financial Accounting Standard No. 123(R) (Norwalk, Conn: FASB, 2004).


Chapter 8

Stock Compensation Plans

  • Noncompensatory plans

    allow employees to purchase stock at a price that is not significantly lower than the current market price.

  • Compensatory plans

    allow employees to purchase stock at a price that is significantly lower than the current market price at the measurement date.


Chapter 8

Stock OptionsNoncompensatory Plans

Criteria stated in APB Opinion No. 25

  • Includes substantially all full-time employees meeting certain criteria.

  • Stock is offered to eligible employees either equally or on the basis of a uniform percentage of salary or wages.

  • Exercise time is limited to a reasonable period.

  • The discount from market price is not significant.


Chapter 8

Stock OptionsNoncompensatory Plans

Criteria stated in FASB No. 123(R)

  • Substantially all full-time employees participate on an equitable basis.

  • The discount from market is small.

  • The plan offers no substantive option feature.


Chapter 8

Stock OptionsNoncompensatory Plans

  • Accounted for based on the cost principle.

  • Record a liability at the time of issuance

    -- Valued at amount contributed by employees.

  • On date of issuance of stock

    -- debit the liability.

    -- credit Capital Stock (for par value) and contributed capital.


Chapter 8

Stock OptionsCompensatory Plans

  • Any plan that fails to meet one of the four criteria for noncompensatory plans is classified as a compensatory plan.

  • The measurement date is the first date when the grantor knows

    -- the number of shares an employee is eligible to receive.

    -- the option price.


Chapter 8

Stock OptionsCompensatory Plans

Determining Expense

  • Compensation expense based on the fair value of the options expected to vest on the date the options are granted to the employee(s) (i.e., the grant date).

Allocating Compensation Expense

  • Over the periods in which employees perform the service—the service period.


Chapter 8

Stock Compensation PlansExample

On January 1, 2006, Nichols Corporation granted 10,000 options to key executives. Each option allows the executive to purchase one share of Nichols’ $5 par value common stock at a price of $20 per share. The options were exercisable within a 2-year period beginning January 1, 2008, if the grantee is still employed by the company at the time of the exercise. On the grant date, Nichols’ stock was trading at $25 per share, and a fair value option-pricing model determines total compensation to be $400,000. On May 1, 2008, 8,000 options were exercised when the market price of Nichols’ stock was $30 per share. The remaining options lapsed in 2010 because executives decided not to exercise their options.


Chapter 8

Stock Compensation PlansExample

Prepare the necessary journal entries related to the stock option plan for the years 2006 through 2010.

1/1/06

No entry on date of grant.

Compensation expense200,000

12/31/06

Paid-in capital-stock options 200,000

($400,000 x ½)

Compensation expense200,000

12/31/07

Paid-in capital-stock options 200,000


Chapter 8

Stock Compensation PlansExample

Prepare the necessary journal entries related to the stock option plan for the years 2006 through 2010.

Cash (8,000 x $20)160,000

5/1/08

Paid-in capital-stock options 320,000

Common stock (8,000 x $5) 40,000

Paid-in capital in excess of par 440,000

($400,000 x 8,000 / 10,000 = $320,000)

1/1/10

Paid-in capital-stock options 80,000

Paid-in capital-expired options 80,000

($400,000 – $320,000)


Chapter 8

Measuring the Fair Value of Fixed Stock Options

  • Requires the application of a complex pricing model.

  • Variables include:

    Exercise price

    Current market price of the stock

    Risk-free rate of interest

    Expected life of the options

    Expected volatility of the stock price

    Expected dividend yield of the stock


Chapter 8

Measuring the Fair Value of Fixed Stock Options

Total Compensation Cost

Number of options

Service Period

Fair Value of an option

Expected annual forfeiture rate


Chapter 8

ARE YOU STAYING ABOVE WATER?


Chapter 8

C

8

hapter

The End

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