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Chapter 11. `. Chapter 11 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 purchase of treasury stock.

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chapter 11 reporting and analyzing stockholders equity
Chapter 11 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 purchase of treasury stock.
  • Differentiate preferred stock from common stock.
chapter 11 reporting and analyzing stockholders equity3
Chapter 11 Reporting and Analyzing Stockholders’ Equity

After studying Chapter 11, you should be able to:

  • 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
  • Possess legal entity
  • Created by law
  • Has most of the rights and privileges of a person
  • Classified by purpose and ownership
    • Purpose - profit or nonprofit
    • Ownership - publicly or privately held
characteristics of a corporation
Characteristics of a Corporation
  • Separate legal existence
  • Limited liability of stockholders
  • Transferable ownership rights
  • Ability to acquire capital
  • Continuous life
  • Corporation management
  • Government regulations
  • Additional taxes
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.
authorized stock
Authorized Stock...

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

OutstandingStock...

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 an arbitrary value per share in the corporate charter.
  • Is usually low because some states levy a tax on the corporation based on par value.
  • The legal capital per share that must be retained in the business.
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
  • Retained earnings (earned capital).
paid in capital
Paid-in Capital...

Amount paid to corporation by stockholders for shares of ownership.

Retained Earnings...

Earned capital held for future use in the business.

accounting for common stock issues
Accounting for Common Stock Issues
  • 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 an additional paid-in capital account.
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

slide15

Hydro-Slide, Inc.

Balance Sheet (partial)

Stockholders' equity

Paid-in capital

Common stock, par value $ 2,000

Additionalpaid-in capital 4,000

Total paid-in capital $ 6,000

Retained earnings 27,000

Total stockholders' equity $33,000

slide16

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
Treasury Stock...

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, 2004, Mead acquires 4,000 shares of its stock at $8 per share.

Treasury Stock 32,000

Cash 32,000

treasury stock20
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.
slide21

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

preferred stock
Preferred Stock...

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 stock23
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 but were not declared during a given period.
  • Are not a liability. No liability exists until a dividend is declared by board of directors.
  • Must be disclosed in the notes to the financial statements.
dividends in arrears27

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

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
Dividend...
  • 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
    • stock
cash dividend
Cash Dividend
  • Is a pro rata distribution of cash to stockholders.
  • A corporation must have 2 things to pay cash dividends:
    • Retained earnings
    • Adequate cash
cash dividend31
Cash Dividend
  • In many states, payment of dividends from legal capital is illegal.
  • 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

On December 1, 2004, 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

The Declaration Date...
  • 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 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 Record Date...

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 dividends38
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 dividends39
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
stock split
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.
stock split41
Stock Split
  • Because a stock split does not affect the balances in stockholders' equity accounts, it is not necessary to journalize a stock split.
retained earnings
Retained Earnings...
  • 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.

slide45

Stockholders Equity With Deficit

  • AMAZON.COM
  • Balance Sheet (Partial)
  • December 31, 2000
  • (in thousands)

Stockholders' equity

Paid-in capital Common Stock $ 3,571

Paid-in capital in excess of par value 1,322,479

Total paid-in capital 1,326,050

Accumulated Deficit 2,293,301

Total stockholders’ equity (deficit) $ (967,251)

slide46

Stockholders Equity Section

  • Kmart, Inc.
  • Balance Sheet (Partial)
  • (in millions)

Stockholders' equity

Common stock, $.01 par value;

1,500,000,000 shares authorized -- 250,000,000; 503,294,515

shares issued $ 503 Capital in excess of par value 1,695

Retained earnings 1,261

Total stockholders' equity$ 3,459

slide47

SARA LEE CORPORATION

Statement of Cash Flows (partial)

For the Year Ended June 30,2001

(in millions)

Cash flow from Financing Activities

Issuance of common stock $ 104

Purchase of common stock (643)

Payment of dividends (486)

Borrowing of long-term debt 1,023

Repayment of long-term debt (390)

Short-term (repayments)borrowing (1,914)

Net cash used in financing activities (2,306)

the payout ratio
The Payout Ratio =

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 equity ratio

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

Return on Equity Ratio =

NET INCOME - PREFERRED STOCK DIVIDENDS

AVERAGE COMMON STOCKHOLDERS’ EQUITY

the dividend yield
The Dividend Yield =

DIVIDENDS DECLARED PER SHARE OF COMMON STOCK

STOCK PRICE AT END OF YEAR

…reports the rate of return an investor earned from dividends.

earnings per share
Earnings Per Share =

NET INCOME - PREFERRED STOCK DIVIDENDS

AVERAGE COMMON SHARES OUTSTANDING

...measures the net income earned on each share of common stock.

price earnings ratio
Price-Earnings Ratio =

MARKET PRICE PER SHARE OF STOCK

EARNINGS PER SHARE

  • In order to make a meaningful comparison of earnings across firms, use the price-earnings ratio.
  • The price-earnings ratio reflects the market’s assessment of a company's future earnings.