9 Sources of Capital: Owners’ Equity Part One: Financial Accounting • The McGraw-Hill Companies, Inc., 1999
Forms of Business Organizations Slide 9-1 Sole Proprietorship Owned by an individual No incorporation fees No special reports Profits taxed at proprietor’s personal tax rate Personally responsible for the entity’s debts Borrow money as an individual
Forms of Business Organizations Slide 9-2 Partnership Owned by two or more persons Each partner is personally liable for all debts incurred by firm Each partner is responsible for business actions of other partners Taxed as individuals
Forms of Business Organizations Slide 9-3 Corporation Legal entity with essentially perpetual existence Granted acharterto operate Taxed as an entity Limited liability to owners Ownership of an individual is easily added or liquidated
Disadvantages of the Corporation Form Slide 9-4 • There may be significant legal and other fees involved in formation. • The corporation’s activities are limited to those specifically granted in its charter. • It is subject to numerous regulations and requirements. • It must secure permission from each state in which it wishes to operate. • Its income is subject to double taxation.
Partnership Equity Slide 9-5 The partnership agreement of Jackson and Curtin provided that Jackson would receive a salary of $20,000 and Curtin a salary of $40,000; that each would receive 8 percent interest on their invested capital; and they they would share any remainder equally. The partnership’s net income for the year is $80,000. Salary $60,000 $20,000 $40,000 Interest on capital 8,000 2,400 5,600 Remainder 12,000 6,000 6,000 Total $80,000 $28,400 $51,600 Total Jackson Curtin
Partnership Equity Slide 9-6 If the partnership agreement is silent concerning the remainder, then it is divided equally. Total Jackson Curtin Salary $60,000 $20,000 $40,000 Interest on capital 8,000 2,400 5,600 Remainder 12,000 6,000 6,000 Total $80,000 $28,400 $51,600
Recording a Common Stock Issue Slide 9-7 Kuick Corporation is authorized to issue 200,000 shares of $1 par value common stock. Of these, 100,000 shares were issued at $7 per share. Cash 700,000 Common Stock at Par 100,000 Additional Paid-In Capital 600,000 100,000 x $1
Cash Dividend Slide 9-8 Kuick Corporation declares a $6,000 dividend on December 15 to be paid on January 15 to holders of record as of January 1. December 15 Retained Earnings 6,000 Dividends Payable 6,000 January 1 (no entry) January 15 Dividends Payable 6,000 Cash 6,000
Stock Dividend Slide 9-9 Kuick Corporation declares and issues a 5 percent stock dividend to the holders of its 100,000 outstanding shares (par value of $1) when the market price of a share is $10.50. 5,000 x $10.50 Retained Earnings 52,500 Common Stock at Par 5,000 Additional Paid-In Capital 47,500 5,000 x $1
Balance Sheet Presentation Slide 9-10 PRESTON COMPANY AND SUBSIDIARIES Consolidated Balance Sheet At December 31 (millions) Common stock, $25 per share $ 77.6 $ 77.5 Capital in excess of par 72.0 60.2 Retained earnings 3.409.4 3.033.9 Treasury stock, at cost (1,653.1) (1,105.0) Total stockholders’ equity $1,905.9 $2,075.6 1998 1997
Net income Number of shares of common stock outstanding Earnings per share = $7,000,000 1,000,000 shares Earnings per share = = $7 Basic Earnings Per Share Slide 9-11 Basic earnings per share is a measurement of the corporation’s per share performance over a period of time. Assume Nugent Corporation had net income of $7 million and 1 million shares of common stock outstanding.
Net income - Preferred dividends Number of shares of common stock outstanding Earnings per share = $7,000,000 - $800,000 1,000,000 shares Earnings per share = = $6.20 Basic Earnings Per Share Slide 9-12 Now, assume that Nugent Corporation also has 100,000 shares of $8 convertible preferred stock.
Net income - Preferred dividends Number of shares of common stock outstanding Earnings per share = $7,000,000 1,200,000 shares Earnings per share = = $5.83 Earnings Per Share Slide 9-13 For diluted earnings per share, we assume that the 100,000 convertible preferred shares are exchanged for 200,000 shares of common stock.
Net income - Preferred dividends Number of shares of common stock outstanding Earnings per share = $7,000,000 1,200,000 shares Earnings per share = = $5.83 Earnings Per Share Slide 9-14 For diluted earnings per share, we assume that the 100,000 convertible preferred shares are exchanged for 200,000 shares of common stock. Note that all the preferred stock is assumed converted, so there would be no dividends. 1,000,000 shares of common stock plus the 200,000 shares assumed from converting preferred stock
Weighted-Average Number of Shares Slide 9-15 Optel Corporation had 1 million shares of common stock outstanding on January 1. On July 1 it issued an additional 500,000 shares. How many weighted-average shares would be used for calculating earnings per share? 1,000,000 x 12/12 = 1,000,000 500,000 x 6/12 = 250,000 Denominator amount 1,250,000
Zero-Coupon Bonds Slide 9-16 Bonds with a total par of $100,000 and carrying zero interest are issued when the current yield is 14 percent. How much should the investor pay for each $1,000 bond? $1,000 x .519 = $519 per $1,000 bond No cash is paid by the borrower until these bonds mature.
If detachable, the warrants can be removed from the debt and used to purchase the issuer’s stock or sold to a third party. Debt With Warrants Slide 9-17 Some corporations issue warrants in conjunction with the issuance of bonds, putting an exercise price on the warrants of about 15 to 20 percent above the current market price of the common stock.
Debt With Warrants Slide 9-18 Some corporations issue warrants in conjunction with the issuance of bonds, putting an exercise price on the warrants of about 15 to 20 percent above the current market price of the common stock. If nondetachable, the debt is accounted for as if it were a convertible debt security--no recognition is given to the equity character of the debt.
Redeemable Preferred Stock Slide 9-19 Redeemable preferred stock not only pays dividends, it may also be redeemed by the investor on or after a certain date. The SEC requires that redeemable preferred stock be listed as a separate item on the balance sheet at it’s redemption price. This item must be listed between the liability and owners’ equity section and not included in the total of either liabilities or owner’s equity.
Redeemable Preferred Stock Slide 9-20 Redeemable preferred stock $ 8,000,000 Stockholders’ equity: Common stock @ $1 par 20,000,000 Additional paid-in capital 75,000,000 Total paid-in capital 95,000,000 Retained earnings 60,000,000 Total stockholders’ equity $155,000,000 The $8 million for redeemable preferred stock is not included.
Chapter 9 TheEnd