Financial Accounting:
Tools for Business Decision Making
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.
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
Publicly Held Corporation
Privately Held Corporation
Separate legal existence
Limited liability of stockholders Transferable ownership rights Ability to acquire capital
Continuous life
Corporation management Government regulations
Separate Legal Existence
Separate and distinct from owners Acts under its own name - not
name of stockholders
May buy, own, and sell property;
borrow money; enter into legally binding contracts; may sue or be sued; pays its own taxes
Owners (stockholders) cannot
Limited Liability of Stockholders
Creditors have recourse only to corporate assets to satisfy claims. Liability of stockholders
limited to investment in corporation.
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
Ability to Acquire Capital
Limited liability of
stockholders coupled
with transferable
ownership rights
Continuous Life
Life of corporation stated in charter - may be perpetual or limited to specific number of
years (can be extended) Corporation is separate
Corporation Management
Stockholders manage corporation indirectly through board of directors.
Board of directors
formulates operating policies
selects officers to execute policy and to
Corporate
Organization
Chart
Additional Taxes
Corporations pay federal and state income taxes. Stockholders pay taxes on cash dividends.
Corporate income is taxed twice - at the
corporate level and at the individual level. With proprietorships and
partnerships, the owner's share of earnings is
Forming a Corporation
States grant corporate charters.
Although a corporation may have
operating divisions in a number of states,
it will be incorporated in only one state.
Some states have laws favorable to the
Forming a Corporation
The corporation establishes by-laws for
conducting its affairs upon receipt of its
charter from the state of incorporation.
A corporation must obtain a license -
subjecting the corporation's operating
activities to the general corporation
Stockholder Rights
Once it is chartered, the corporation sells stock.
When a corporation has only one class of stock it is common stock.
Ownership rights are specified in the
articles of incorporation or in the by-laws. Proof of stock ownership is evidenced by a
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
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
The amount of stock a corporation is
authorized to sell as indicated in the
corporate charter.
Disclose the number of shares
Corporations Can Issue Stock
Directly to investors (typical in closely
held corporations)
Indirectly through an investment
Factors Involved in Setting Price of
Stock
Company's anticipated future
earnings
Its expected dividend rate per share
Its current financial position
Current state of the economy
Par Value Stock
Is capital stock that has been assigned an arbitrary value per share in the corporate charter.
Par Value
Represents the legal capital per share
that must be retained in the business.
Legal Capital
No-Par Value Stock
Is capital stock that has
not
been assigned
a value per share in the corporate
charter.
Stated Value of No-Par Stock
Is the amount per share assigned by
the board of directors to no-par stock.
Does not indicate or correspond to the
Relationship of Par and No-Par
Value to Legal Capital
Stock Legal Capital Per Share
Par value Par value
No-par value with stated value
Stated value
No-par value without stated value
Stockholders’ Equity Section of a
Corporation’s Balance Sheet...
Two Parts:
Paid-in (contributed) capital
Retained earnings (earned capital)
Paid-in Capital
Is the amount paid in to the
corporation by stockholders in
Retained Earnings
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
Issuing Stock at Par
Assume 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
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
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
Hydro-Slide, Inc.
Partial Balance Sheet
Treasury Stock
Is a corporation's own stock
that has been issued fully paid for
reacquired by the corporation
Corporations Acquire Treasury
Stock to...
Reissue the shares to officers and employees under
bonus and stock compensation plans.
Increase trading of the company's stock in the
securities market in the hopes of enhancing its market value.
Have additional shares available for use in the
acquisition of other companies.
Reduce the number of shares outstanding and
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
Mead, Inc.
Partial Balance Sheet
Purchase of Treasury Stock
On February 1, 1998, Mead acquires 4,000 shares of its stock at $8 per share.
Treasury Stock
32,000
Cash
32,000
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 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
Mead, Inc.
Partial Balance Sheet
Outstanding Stock
Preferred Stock
Is capital stock that has contractual
preferences over common stock in certain
areas.
Preferred Stock may have priority to:
Dividends
Assets in the event of liquidation
Preferred Stock
Assume Stine 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
no-Dividend Preferences
Preferred stockholders have the right to
share in the distribution of corporate income before common stockholders.
If the dividend rate of preferred stock is $5 per share, common shareholders will not receive any dividends in the current year
until preferred stockholders have received $5 per share.
Cumulative Dividend
A feature of preferred stock entitling
the stockholder to receive current
and unpaid prior-year dividends
Dividends in Arrears
Are preferred dividends that were
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) $
Not a liability because no obligation
exists until a dividend is declared by
the board of directors
Must be disclosed in the notes to the
financial statements
Liquidation Preference
Is a feature that gives preferred
Dividend
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
Cash Dividend
For a corporation to pay a cash
dividend, it must have the following:
Retained earnings
Adequate cash
Declared dividends
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
Entries for Cash Dividends
Three dates are important in
connection with dividends:
the declaration date
the record date
the payment date
Month a nd ye a rThe Declaration Date
The date the board of directors
formally declares the cash dividend and
announces it to stockholders
Commits the corporation to a binding
legal obligation that cannot be
rescinded
The Declaration Date
On December 1, 1998, the directors of Media
General declare a $0.50 per share cash dividend on 100,000 shares of $10 par value common
stock.
The dividend is $50,000 (100,000 x $0.50).
12/1 Retained Earnings 50,000
The Record Date
The date when ownership of the
outstanding shares is determined for
dividend purposes.
The Payment Date
The date dividend checks are mailed to the
stockholders.
January 20 is the payment date for
Media General.
Stock Dividends
A pro rata distribution of the corporation's own stock to stockholders
Paid in stock
Results in a decrease in retained earnings and an increase in paid-in capital
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).
Reasons for Stock Dividends
To satisfy stockholders' dividend expectations without spending cash
To increase the marketability of its stock by
increasing the number of shares outstanding and thereby decreasing the market price per share
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.
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.
The number of shares to be issued is 5,000 (50,000 x 10%).
Retained Earnings 75,000
Common Stock Dividends 50,000 Distributable
Paid-in Capital in Excess 25,000
of Par Value
The Common Stock Dividends Distributable is an equity account; not a liability account - because
Stock Split
The issuance of additional shares
of stock to stockholders
In a stock split, the number shares is
increased in the same proportion that the
par or stated value per share is decreased.
A stock split does not have any effect on
total paid-in capital, retained earnings, and
total stockholders' equity.
With a stock split the number of shares
increases.
Because a stock split does not affect
the balances in stockholders' equity
accounts, it is not necessary to
journalize a stock split.
Retained Earnings
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.
Deficit
A debit balance in retained
earnings and reported as a
deduction in the stockholders'
Retained Earnings Restrictions
Legal, contractual, or voluntary
circumstances that make a
portion of retained earnings
Stockholders' equity
Common stock, $.02 1/2 par value; shares authorized -- 250,000,000;
shares issued-- 93,340,652 $ 1,945 Additional paid-in capital 308,320
Retained earnings 821,243
KNIGHT-RIDDER, INC.
Partial Balance Sheet
(in millions)
The Payout Ratio =
TOTAL CASH DIVIDENDS PAID ON COMMON STOCK NET INCOME
Measures the percentage of earnings
The Dividend Yield =
DIVIDENDS PAID PER SHARE STOCK PRICE AT END OF YEAR
Reports the rate of return an
Earnings Per Share =
NET INCOME - PREFERRED STOCK DIVIDENDS AVERAGE COMMON SHARES OUTSTANDING
Price-Earnings Ratio =
MARKET PRICE PER SHARE OF STOCK EARNINGS PER SHARE
Return on Common
Stockholders’ Equity Ratio =
NET INCOME -PREFERRED STOCK DIVIDENDS
AVERAGE COMMON STOCKHOLDERS’ EQUITY
COP Y RI GHT
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