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Stockholders’ Equity

ACG 2021Financial Accounting

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Characteristics of a Corporation

Separate legal entity Exists separately from owners Can enter in contracts, sue or be sued

Continuous life Change of ownership does not end Corporate life Ownership can be transferred

Limited liability Only Corporate debts No personal obligation for corporate liabilities

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Characteristics of a Corporation Separation of ownership and management

Stockholders own the corporation Elect Board of Directors Sets Policies and appoints officers

Elect Chairperson (CEO) Elect President (COO)

In charge of day-to-day operations Corporate taxation

Franchise Tax (some states) Corporate Taxes on Income

Double Taxation Corporation is Taxed on Earnings Individuals are taxed on dividends from earnings

Government regulation Disclosure of Information for Stakeholders (Investors, Creditors, Taxing

Authorities, etc.) to make informed decisions Accounting

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Advantages of a Corporation

1. Can raise more capital than a proprietorship or partnership can

2. Continuous life3. Ease of transferring ownership4. Limited liability of stockholders

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Disadvantages of a Corporation

1. Separation of ownership2. Corporate taxation3. Government regulation

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Stockholders

Board of Directors

Chairperson of the Board

President

Authority Structure of a Corporation

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Vote

Dividends

Liquidation

Preemption

Stockholders’ Rights

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Stockholders Rights Unless Withheld by Agreement

Voting One Vote for each share owned

Dividends Right to Receive proportionate share

Liquidation Right to Receive proportionate share of Net

Assets Preemption

Right to Maintain one’s proportionate ownership Usually withheld from stockholders

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ACG 2021Financial AccountingStockholder’s Equity Section of the

Balance Sheet

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Stockholders’ Equity

Two main components: Paid-in capital (contributed capital)

Amount contributed by stockholders Stock (At Par) Additional Paid in Capital

Retained earnings Equity Earned but not paid in Dividends

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What is Par Value The par value of a stock was the

share price upon initial offering; the issuing company promised not to issue further shares below par value, so investors could be confident that no one else was receiving a more favorable issue price. This was far more important in unregulated equity markets than in the regulated markets that exist today.

Quoted from Wikipedia at http://en.wikipedia.org/wiki/Par_value

Most common stocks issued today do not have par values; those that do (usually only in jurisdictions where par values are required by law) have extremely low par values, for example a penny par value on a stock issue at USD$25/share.

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Capital Stock Authorized shares

Total # of Shares available for sale Outstanding shares

Total # of Shares actually sold Represents 100% ownership Often Less than shares authorized

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Types of Capital Stock Common Stock

Residual Equity Holder Paid Dividends after Preferred Stockholders After Creditors & Preferred Stockholders are

satisfied, Common stockholder receives liquidation

Dividends are not subject to Limit Voting Rights (controls the corporation)

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Types of Capital Stock

Preferred Stock Rights and Privileges

Current Dividend Preference May be in Arrears

Though in Arrears is not a liability Dividends are still discretionary

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Dividend Example

Assumptions: Preferred Stock is 6%, $100 par value, two years in arrears,1000 Shares outstanding; common stock is $10 par, 1000 shares outstanding

Case Dividend Declared Non-Cumulative Pfd CommonA 1000 1000 0B 7000 6000 1000C 13000 6000 7000D 19000 6000 13000

Cumulative Pfd Common ArrearsA 1000 1000 0 17000B 7000 7000 0 11000C 13000 13000 0 5000D 19000 18000 1000

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ACG 2021Financial AccountingAccounting for Issuance of Common Stock and Re-purchase of Treasury

Stock

Common Stock at Par

General Journal

Date Accounts and Explanations PR Debit Credit Jan 8 Cash (6,200 x $10) 62,000

Common Stock 62,000To record issuance of stock

Suppose IHOP’s common stock has a par value of $10 per share. The company issues 6,200 shares of common stock at par. What is the entry?

Common Stock above Par

General Journal

Date Accounts and Explanations PR Debit Credit Jul 23 Cash (6,200 x $10) 62,000

Common Stock 62 Paid-in Capital in Excess of Par 61,938To record issuance of stock

Suppose IHOP’s common stock has a par value of $0.01 per share. The company issues 6,200 shares of common stock for $10 per share. What is the entry?

Balance SheetCommon Stock Above Par

Common Stock, $.01 par; 40,000 shares authorized, 6,200 shares issued $ 62Paid-in capital n excess of par 61,938Total paid-in capital $ 62,000Retained earnings 194,000Total stockholders’ equity $256,000

Stockholders’ Equity

Common Stock at ParSuppose IHOP’s common stock is no par value stock.

The company issues 6,200 shares of common stock for $20 per share. What is the entry?

General Journal

Date Accounts and Explanations PR Debit Credit Jul 23 Cash (6,200 x $20) 124,000

Common Stock 124,000To record issuance of stock

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Preferred Stock Accounting for preferred stock follows the

pattern illustrated for common stock.

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Treasury Stock Transactions Shares that a company has issued and

later reacquired. Shares needed for Employee Stock Plan

Distribution Increase net assets

Buy Low, Sell High Avoidance of a takeover

Contra Stockholder Equity

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IHOP Corp. Before Purchaseof Treasury Stock

Common Stock $ 203Paid-in capital in excess of par 69,655Retained earnings 193,632Total equity $263,490

Stockholder’s Equity at December 31, 2005(if no treasury stock purchased)

IHOP Corp. Purchaseof Treasury Stock

During 2005, IHOP paid $5,170 to purchase 288 shares of its common stock as treasury stock.

General Journal

Date Accounts and Explanations PR Debit Credit Nov 1 Treasury Stock 5,170

Cash 5,170Purchased treasury stock

IHOP Corp. After Purchaseof Treasury Stock

Common Stock $ 203Paid-in capital in excess of par 69,655Retained earnings 193,632Less: Treasury stock (288 shares at cost) (5,170)Total equity $258,320

Stockholder’s Equity at December 31, 2005(with treasury stock purchased)

Sale of Treasury Stock

Assume that on July 22, 2006, the shares of treasury stock are sold for $5,300.

General Journal

Date Accounts and Explanations PR Debit Credit Jul 22 Cash 5,300

Treasury Stock 5,170Paid-in Capital from Treasury Stock Transactions 130

Sold treasury stock(Loss would require debit of retained earnings)

IHOP Corp. After Sale of Treasury Stock

Common Stock $ 203Paid-in capital in excess of par 69,785Retained earnings 193,632Total equity $263,620Equity before purchase of treasury stocks 263,490Increase in stockholders’ equity $ 130

Stockholder’s Equity at December 31, 2006

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Retirement of Stock Decreases the outstanding stock of the corporation Retired shares cannot be reissued There is no gain or loss on retirement

General Journal

Date Accounts and Explanations PR Debit Credit Common Stock 100

Additional Paid in Capital 10,900 Cash 11,000

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Equity Transactions on the Cash Flow Statement

Proceeds from issuance of common stock $172,000Purchase of treasury stock (5,170,000)Net cash used by financing activities $(4,998,000)

During 2003, IHOP issued stock,repurchased stock, but paid no dividends.

Cash flows from financing activities:

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ACG 2021Financial AccountingRetained Earnings and Dividends

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Retained Earnings Is Not Cash Is Not a Reserve held for Dividends Is the account used to Record

Cash Dividends Stock Dividends

Is Profits Reinvested into Corporation Credit Balance = Earnings > Losses + Dividends Debit Balance (Deficit) = Earnings < Losses +

Dividends

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Dividends and Splits Dividend - corporation’s return to its

stockholders of some of the benefits of earnings Cash or Stock

Stock split - increase in the number of authorized, issued, and outstanding shares

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Dividend Dates Declaration date

BOD announces dividend Date of record

Stockholders who own stock by this date will receive dividend Payment date

When dividend is paid

Preferred Stock DividendsThe preferred stock of Pinecraft is cumulative. Suppose the

company passed the 20x6 preferred dividend of $150,000. In 20x7, the company declares a $500,000 dividend.

General Journal

Date Accounts and Explanations PR Debit Credit Retained Earnings 500,000

Dividends Payable-Preferred 300,000*Dividends Payable-Common 200,000

Declared a cash dividend*$150,000 x 2 years

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Stock Dividend

IHOP declared a 10% stock dividend in 2006. Assume IHOP had 20,000,000 shares of common stock outstanding. The stock is trading for $15 per share. How would this stock dividend be recorded?

Stock Dividend

General Journal In thousandsDate Accounts and Explanations PR Debit Credit

Retained Earnings(20,000,000 X 10% X $15) 30,000

Common Stock (20,000,000 X 10% X $0.01) 20

Paid-in Capital in Excess of ParCommon 29,980

Distributed a 10% stock dividend

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Stock Splits Corporations like stock prices within a specific trading

range Higher prices might discourage small investors The more widely held a stock (small and large investors) the less

volatile the market pricing may be Thus, stock splits are used to reduce the market price by

Increasing the number of authorized, issued, and outstanding shares of stock

Proportionate reduction in stock’s par value Decreasing market price

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Stock Split Example

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ACG 2021Financial Accounting

Stock Valuations

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Stock Values Market value

Market Price Redemption value

Set price for Preferred stock Not Equity but a liability

Liquidation value Amount paid to Preferred stockholders in case the

company liquidates Book value

Amount of Stockholders Equity per outstanding share

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Book Value Per Share Preferred stock = (Redemption value + Dividends in arrears) ÷ Number of

shares of preferred outstanding Common stock = (Total stockholders’ equity – Preferred equity) ÷ Number of

shares of common stock outstanding

Book Value

Preferred stock, 6%, $100 par, 5,000 shares authorized, 400 shares issued, redemption value $130 per share $ 40,000Additional paid-in capital in excess of par –

preferred 4,000Common stock, $10 par, 20,000 shares

authorized, 5,500 shares issued 55,000Additional paid-in capital in excess of par –

common 72,000Retained earnings 85,000Treasury stock – common, 500 shares at cost ( 15,000)Total stockholders’ equity $241,000

Stockholders’ Equity

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Book Value Common Stock

Suppose that four years’ (including the current year) cumulative preferred dividends are in arrears and that preferred stock has a redemption value of $130 per share.

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Book Value – Preferred StockPreferred equity:Redemption value (400 shares × 130) $ 52,000Cumulative dividends ($40,000 × $0.06 × 4 yrs) 9,600Preferred equity $ 61,600

61,600 / 400 = $154.00

Book Value Common StockPreferred equity:Redemption value (400 shares × 130) $ 52,000Cumulative dividends ($40,000 × $0.06 × 4 yrs) 9,600Preferred equity $ 61,600

Common equity:Total stockholders’ equity $241,000Less preferred equity – 61,600Common equity $179,400Book value per share: $179,400 ÷ 5,000 shares* $ 35.88

*5,500 shares issued minus 500 treasury shares

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ACG 2021Financial Accounting

Ratios: Return on Assets and Return on Equity

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Ratio Definitions Return on Assets

Measure of a company’s ability to generate profits from the use of its assets

(Net income + Interest expense) ÷ Average total assets

Return on Equity Measure of income earned from common stockholders’

investment in the company (Net income – Preferred dividends) ÷ Average common

stockholders’ equity

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End of Chapter 9