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Financial Accounting: Tools for Business Decision Making, 4th Ed. Kimmel, Weygandt, Kieso. CHAPTER 11 Prepared by Ellen L. Sweatt Georgia Perimeter College and Barbara Muller Arizona State University West. Chapter 11. REPORTING AND ANALYZING STOCKHOLDERS’ EQUITY.

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slide1

Financial Accounting:Tools for Business Decision Making, 4th Ed.

Kimmel, Weygandt, Kieso

CHAPTER 11

Prepared by

Ellen L. Sweatt

Georgia Perimeter College

and

Barbara Muller

Arizona State University West

slide2

Chapter 11

REPORTING AND ANALYZING STOCKHOLDERS’ EQUITY

reporting and analyzing stockholders equity
Reporting and Analyzing Stockholders’ Equity

After studying Chapter 11, you should be able to:

  • Identify and discuss the major characteristics of a corporation.
  • Record the issuance of common stock.
  • Explain the accounting for the purchase of treasury stock.
  • Differentiate preferred stock from common stock.
reporting and analyzing stockholders equity4
Reporting and Analyzing Stockholders’ Equity
  • Prepare the entries for cash dividends and understand the effect of stock dividends and stock splits.
  • Identify the items that affect retained earnings.
  • Prepare a comprehensive stockholders' equity section.
  • Evaluate a corporation's dividend and earnings performance from a stockholder's perspective.
corporation
Corporation
  • Created by law
  • Legal entity
  • Has most of the rights and privileges of a person
  • Classified by purpose and ownership
    • Purpose - profit or nonprofit
    • Ownership - publicly or privately held
publicly held corporation
Publicly Held Corporation...

May have thousands of stockholders.

Its stock is regularly traded on national securities markets.

Privately Held Corporation...

Usually has only a few stockholders and does not offer its stock for sale to general public.

characteristics of a corporation

11

Characteristics of a Corporation

1

  • Separate legal existence
  • Limited liability of stockholders
  • Transferable ownership rights
  • Ability to acquire capital
  • Continuous life
  • Corporation management
  • Government regulations
  • Additional taxes
separate legal existence
Separate Legal Existence
  • Separate and distinct from its owners.
  • Acts under its own name.
  • May buy, own, sell property; borrow money; enter into legally binding contracts; may sue or be sued; pays its own taxes.
  • Owners (stockholders) cannot bind corporation unless owners are agents of the corporation.
limited liability of stockholders
Limited Liability of Stockholders
  • Creditors have recourse only to corporate assets to satisfy their claims.
  • Liability of stockholders limited to their investment in their corporation.
  • Creditors have no legal claim on personal assets of stockholders unless fraud has occurred.
  • Stockholders’ losses limited to amount of capital invested.
transferable ownership rights
Transferable Ownership Rights
  • Ownership evidenced by shares of stock
  • Transfer of ownership among stockholders has no effect on corporation’s operating activities or assets, liabilities and total stockholders' equity.
  • Corporation does not participate in transfer of

ownership rights after original sale.

ability to acquire capital
Ability to Acquire Capital

Limited liability of stockholders coupled with transferable ownership rights make it easy to raise capital.

continuous life
Continuous Life
  • Life of corporation is stated in its charter - may be perpetual or limited to specific number of years (can be extended).
  • Corporation is separate legal entity, thus life not affected by withdrawal, death, or incapacity of a stockholder.
corporation management
Corporation Management
  • The corporation establishes by-laws upon receipt of its charter from the state of incorporation.
  • Stockholders manage corporation indirectly through board of directors.
  • Board of directors
    • formulates operating policies
    • selects officers to execute policy and to perform daily management functions.
forming a corporation
Forming a Corporation
  • A corporation can operate in various states (must have a license from each state in which it does business) but can be incorporated in only one state.
stockholder rights
Stockholder Rights
  • Once chartered, the corporation sells stock .
  • If only one class of stock - called common stock.
  • Ownership rights specified in the articles of incorporation or by-laws.
  • Proof of stock ownership is a printed or engraved form known as a stock certificate.
stock certificate shows
Stock Certificate Shows...
  • Name of the corporation
  • Stockholder's name
  • Class and special features of the stock
  • The number of shares owned
  • The signatures of duly authorized corporate officials.
questions in issuing stock
Questions in Issuing Stock...
  • How many shares should be authorized for sale?
  • How should the stock be issued?
  • At what price should the shares be issued?
authorized stock
Authorized Stock...

Maximum amount of stock a corporation is allowed to sell as authorized by corporate charter.

Issued Stock...

Number of shares of issued stock have been sold and been paid for.

Outstanding Stock...

Number of shares of issued stock

that are being held by stockholders.

corporations can issue stock
Corporations Can Issue Stock...
  • Directly to investors (typical in privately held corporations).
  • Indirectly through an investment banking firm (customary with publicly held corporations).
par value stock
Par Value Stock...
  • Is capital stock that has been assigned a value per share in the corporate charter.
  • Legal capital per share must be retained in the business for the protection of corporate creditors.
no par value stock
No-Par Value Stock...
  • Capital stock that has not been assigned a value per share in the corporate charter.

Stated Value of No-Par Stock

  • Amount per share assigned by the board of directors to no-par stock.

Par Value and Stated Value have NO

relationship to market value.

stockholders equity section of a corporation s balance sheet
Stockholders’ Equity Section of a Corporation’s Balance Sheet

Two Parts:

  • Paid-in (contributed) capital -Amount paid tocorporation by stockholders in exchange for shares of ownership.
  • Retained earnings (earned capital) -Earned capital held for future use in the business.
review
Review

Which of the following represents the maximum number of shares a corporation can issue?

  • Outstanding shares
  • Issued shares
  • Authorized Shares
  • Treasury Shares
review29
Review

Which of the following represents the maximum number of shares a corporation can issue?

  • Outstanding shares
  • Issued shares
  • Authorized Shares
  • Treasury Shares
accounting for common stock issues

11

Accounting for Common Stock Issues

2

  • The issue of common stock affects only paid-in capital accounts.
  • When the issuance of common stock for cash is recorded, the par value of the shares is credited to common stock.
  • The portion of the proceeds above or below par value is recorded in a separate paid-in capital account.
issuing stock at par
Issuing Stock at Par

Hydro-Slide, Inc., issues 1,000 shares of $1 par value of common stock at par for cash.

Cash 1,000 Common Stock 1,000

issuing stock above par
Issuing Stock Above Par

If Hydro-Slide, Inc., issues an additional 1,000 shares of the $1 par value common stock for cash at $5 per share, the entry is:

Cash 5,000

Common Stock 1,000

Paid-in Capital in 4,000

Excess of Par Value

slide33

Hydro-Slide, Inc.

Balance Sheet (partial)

Stockholders' equity

Paid-in capital

Common stock $ 2,000

Paid-in capital in excess of par 4,000

Total paid-in capital $ 6,000

Retained earnings 27,000

Total stockholders' equity $33,000

slide34

Mead, Inc.

Balance Sheet (partial)

Stockholders' equity

Paid-in capital

Common stock,$5par value,

100,000 shares issued and

outstanding $ 500,000

Retained Earnings 200,000

Total stockholders’ equity $ 700,000

BEFORE TREASURY STOCK TRANSACTION

treasury stock

11

Treasury Stock...

3

Is a corporation's own stock

  • that has been issued
  • fully paid for
  • reacquired by the corporation
  • held in its treasury for future use.
corporations acquire treasury stock to
Corporations Acquire Treasury Stock to...
  • Reissue shares to officers and employees under bonus and stock compensation plans.
  • Increase trading of company's stock in securities market in hopes of enhancing market value.
  • Have additional shares available for use in acquisition of other companies.
  • Reduce number of shares outstanding thereby increasing earnings per share.
  • Prevent a hostile takeover.
purchase of treasury stock
Purchase of Treasury Stock

On February 1, 2007, Mead acquires 4,000 shares of its stock at $8 per share.

Treasury Stock 32,000

Cash 32,000

treasury stock38
Treasury Stock
  • The Treasury Stock account would increase by the cost of the shares purchased - $32,000.
  • The original paid-in capital account, Common Stock, would not be affected because the number of issued shares does not change.
  • Treasury stock is deducted from total paid-in capital and retained earnings in the stockholders' equity section of the balance sheet.
slide39

Mead, Inc.

Balance Sheet (partial)

Stockholders' equity

Paid-in capital

Common stock,$5par value,

100,000 shares issued and

96,000 outstanding $ 500,000

Retained Earnings 200,000

Total stockholders’ equity 700,000

Less: Treasury Stock 32,000

Total stockholders’ equity $ 668,000

AFTER TREASURY STOCK TRANSACTION

review40
Review

In the stockholders’ equity section, the cost of treasury stock is deducted from:

  • total paid-in capital and retained earnings
  • retained earnings
  • total stockholders’ equity
  • common stock in paid-in-capital
review41
Review

In the stockholders’ equity section, the cost of treasury stock is deducted from:

  • total paid-in capital and retained earnings
  • retained earnings
  • total stockholders’ equity
  • common stock in paid-in-capital
preferred stock

11

Preferred Stock...

4

Capital stock that has contractual preferences over common stock in certain areas.

  • Dividends
  • Assets in the event of liquidation

Preferred stockholders do not have voting rights.

preferred stock43
Preferred Stock
  • Assume Corporation issues 10,000 shares of $10 par value preferred stock for $12 cash per share.

Cash 120,000

Preferred Stock 100,000

Paid-in Capital in Excess 20,000

of Par Value--Preferred Stock

(Preferred stock may have either a par value or no-par value.)

dividend preferences
Dividend Preferences
  • Preferred stockholders have the right to share in the distribution of corporate income before common stockholders.
  • The first claim to dividends does not guarantee dividends.
cumulative dividend
Cumulative Dividend...

Is a feature of preferred stock entitling the stockholder to receive current and unpaid prior-year dividends before common stockholders receive any dividends.

dividends in arrears
Dividends in Arrears...
  • Are preferred dividends that were scheduled to be declared but were not declared during a given period.
  • Are not a liability. No obligation exists until a dividend is declared by the board of directors.
  • Must be disclosed in the notes to the financial statements.
dividends in arrears47
Dividends in Arrears

Scientific-Leasing has 5,000 shares of 7%, $100 par value cumulative preferred stock outstanding.

The annual dividend is $35,000 (5,000 x $7 per share).

Dividends are 2 years in arrears

Dividends in arrears ($35,000 x 2 years) $ 70,000 Current-year dividends 35,000 Total preferred dividends $105,000

liquidation preference
Liquidation Preference

Is a feature that gives preferred stockholders preference to corporate assets in the event of liquidation.

dividend

11

Dividend...

5

  • Is a distribution by a corporation to its stockholders on a pro rata basis.
  • Pro rata means that if you own 10% of the common shares, you will receive 10% of the dividend.
  • Dividend forms:
    • cash
    • property
    • script (promissory note to pay cash)
    • stock
cash dividend
Cash Dividend
  • Is a pro rata distribution of cash to stockholders.
  • A corporation must have 3 things to pay cash dividends:
    • Retained earnings
    • Adequate cash
    • Declared dividends
cash dividend51
Cash Dividend
  • In many states, payment of dividends from legal capital is prohibited.
  • Payment of dividends from paid-in capital in excess of par is legal in some states.
  • Payment of dividends from retained earnings is legal in all states.
  • Companies are frequently constrained by agreements with lenders to pay dividends only from retained earnings.
entries for cash dividends
Entries for Cash Dividends

Three dates are important in connection with dividends:

  • the declaration date
  • the record date
  • the payment date
the declaration date
TheDeclaration Date...

On December 1, 2007, the directors of Media General declare a $.50 per share cash dividend on 100,000 shares of $10 par value common stock.

The dividend is $50,000 (100,000 x $.50).

12/1 Retained Earnings 50,000

Dividends Payable 50,000

  • Is the date the board of directors declares the cash dividend.
  • Commits the corporation to a binding legal obligation that cannot be rescinded.
the record date
The Record Date...

The Payment Date...

  • The date dividend checks are mailed.
  • January 20 is the payment date for Media General.
  • Jan 20 Dividends Payable 50,000
    • Cash 50,000

The date ownership of the outstanding shares is determined for dividend purposes. Dec 20 No Entry Necessary.

a stock dividend
A Stock Dividend...
  • Is a pro rata distribution of the corporation's own stock to stockholders.
  • Is paid in stock.
  • Results in a decrease in retained earnings and an increase in paid-in capital.
  • Does not decrease total stockholders' equity or total assets.
  • Is often issued by companies that do not have adequate cash to issue a cash dividend.
stock dividends
Stock Dividends
  • You have a 2% ownership interest in Cetus Inc., owning 20 of its 1,000 shares of common stock.
  • In a 10% stock dividend, 100 shares (1,000 x 10%) of stock would be issued. You would receive two shares (2% x 100), but your ownership interest would remain at 2% (22 /1,100).
  • You now own more shares of stock, but your ownership interest has not changed.
reasons for stock dividends
Reasons for Stock Dividends
  • To satisfy stockholders' dividend expectations without spending cash.
  • To increase marketability of its stock by increasing number of shares outstanding and decreasing market price per share.
  • To emphasize that a portion of stockholders' equity has been permanently reinvested in business and is unavailable for cash dividends.
stock dividends58
Stock Dividends
  • A small stock dividend (less than 20%-25% of the corporation's issued stock) is recorded at the fair market value per share.
  • A large stock dividend (greater than 20%-25% of the corporation's issued stock) is recorded at par or stated value per share.
stock split
Stock Split

Because a stock split does not affect the balances in stockholders' equity accounts, it is not necessary to journalize a stock split.

stock split60
Stock Split...
  • Is the issuance of additional shares of stock to stockholders accompanied by:
    • A reduction in the par or stated value.
    • An increase in number of shares.
  • A stock split does not have any effect on total paid-in capital, retained earnings, and total stockholders' equity.
review61
Review

Vista, Inc. had 300,000 shares of common stock outstanding when a 30% stock dividend was declared and issued. How many shares were outstanding after the stock dividend?

  • 390,000
  • 330,000
  • 300,000
  • 309,000
review62
Review

Vista, Inc. had 300,000 shares of common stock outstanding when a 30% stock dividend was declared and issued. How many shares were outstanding after the stock dividend?

  • 390,000
  • 330,000
  • 300,000
  • 309,000
retained earnings

11

Retained Earnings...

6

  • Is net income that is retained in the business.
  • The balance in retained earnings is part of the stockholders' claim on the total assets of the corporation.
  • Retained earnings does not represent a claim on any specific asset.
deficit
Deficit

Is a debit balance in retained earnings and is reported as a deduction in the stockholders' equity section of the balance sheet.

retained earnings restrictions
Retained Earnings Restrictions...

Are legal, contractual or voluntary circumstances that make a portion of retained earnings currently unavailable for dividends.

the payout ratio

11

The Payout Ratio =

8

CASH DIVIDENDS DECLARED ON COMMON STOCK

NET INCOME

… measures the percentage of earnings distributed in the form of cash dividends to common stockholders.

return on common stockholders equity ratio
Return on Common Stockholders’ Equity Ratio =

...measures the profitability from the stockholders’ point of view.

NET INCOME - PREFERRED STOCK DIVIDENDS

AVERAGE COMMON STOCKHOLDERS’ EQUITY

stock dividends73
Stock Dividends
  • Medland Corporation has $300,000 in retained earnings and declares a 10% stock dividend on its 50,000 shares of $10 par value common stock.
  • The current fair market value of the stock is $15 per share.
  • Retained Earnings 75,000
  • Common Stock Dividends 50,000 DistributablePaid-in Capital in Excess 25,000 of Par Value
review74
Review

Roger is nearing retirement and would like to invest in a stock that will provide a good steady income supply. Roger should choose a stock with a:

a) high current ratio.

b) high dividend payout.

c) high earnings per share.

d) high price-earnings ratio.

review75
Review

Roger is nearing retirement and would like to invest in a stock that will provide a good steady income supply. Roger should choose a stock with a:

a) high current ratio.

b) high dividend payout.

c) high earnings per share.

d) high price-earnings ratio.