ch11
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Transcript of ch11
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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 Collegeand
Barbara Muller
Arizona State University West
Chapter 11
REPORTING AND REPORTING AND ANALYZING ANALYZING
STOCKHOLDERS’ STOCKHOLDERS’ EQUITYEQUITY
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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.
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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.
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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...
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.
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Separate legal existence Limited liability of stockholders Transferable ownership rights Ability to acquire capital Continuous life Corporation management Government regulations Additional taxes
Characteristics of a Corporation
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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.
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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.
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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.
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Ability to Acquire Capital
Limited liability of stockholders coupled with transferable ownership rights make it easy to raise capital.
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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.
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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.
Corporate Organization Chart
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Additional Taxes
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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.
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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.
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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.
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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?
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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.
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Corporations Can Issue Stock...
Directly to investors (typical in privately held corporations).
Indirectly through an investment banking firm (customary with publicly held corporations).
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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.
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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.
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Stockholders’ Equity Section of a Corporation’s Balance Sheet
Two Parts: Paid-in (contributed) capital - Amount paid to
corporation by stockholders in exchange for shares of ownership.
Retained earnings (earned capital) -Earned capital held for future use in the business.
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ReviewReview
Which of the following represents the Which of the following represents the maximum number of shares a corporation can maximum number of shares a corporation can issue?issue?
a.a. Outstanding sharesOutstanding shares
b.b. Issued sharesIssued shares
c.c. Authorized SharesAuthorized Shares
d.d. Treasury SharesTreasury Shares
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ReviewReview
Which of the following represents the Which of the following represents the maximum number of shares a corporation can maximum number of shares a corporation can issue?issue?
a.a. Outstanding sharesOutstanding shares
b.b. Issued sharesIssued shares
c.c. Authorized SharesAuthorized Shares
d.d. Treasury SharesTreasury Shares
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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 a separate paid-in capital account.
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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
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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 5,000Common Stock 1,000
Paid-in Capital in 4,000
Excess of Par Value
Issuing Stock Above Par
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 27,000Total stockholders' equity $33,000
Hydro-Slide, 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
Mead, Inc.Balance Sheet (partial)
BEFORE TREASURY STOCK TRANSACTION
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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.
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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.
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Purchase of Treasury Stock
On February 1, 2007, Mead acquires 4,000 shares of its stock at $8 per share.
Treasury Stock 32,000Cash
32,000
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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.
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
32,000Total stockholders’ equity $
668,000
Mead, Inc.Balance Sheet (partial)
AFTER TREASURY STOCK TRANSACTION
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ReviewReview
In the stockholders’ equity section, the cost In the stockholders’ equity section, the cost of treasury stock is deducted from:of treasury stock is deducted from:
a.a. total paid-in capital and retained earningstotal paid-in capital and retained earnings
b.b. retained earningsretained earnings
c.c. total stockholders’ equitytotal stockholders’ equity
d.d. common stock in paid-in-capitalcommon stock in paid-in-capital
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ReviewReview
In the stockholders’ equity section, the cost In the stockholders’ equity section, the cost of treasury stock is deducted from:of treasury stock is deducted from:
a.a. total paid-in capital and retained earningstotal paid-in capital and retained earnings
b.b. retained earningsretained earnings
c.c. total stockholders’ equitytotal stockholders’ equity
d.d. common stock in paid-in-capitalcommon stock in paid-in-capital
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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.
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Preferred Stock
Assume Corporation issues 10,000 shares of $10 par value preferred stock for $12 cash per share.
Cash 120,000Preferred Stock 100,000Paid-in Capital in Excess
20,000 of Par Value--Preferred Stock
(Preferred stock may have either a par value or no-par value.)
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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.
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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.
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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.
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Dividends in Arrears
Dividends in arrears ($35,000 x 2 years) $
70,000 Current-year dividends 35,000 Total preferred dividends $105,000
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
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Liquidation Preference
Is a feature that gives preferred stockholders preference to corporate assets in the event of liquidation.
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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 property script (promissory note to pay cash) stock
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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
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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.
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Entries for Cash Dividends
Three dates are important in connection with dividends:
the declaration date the record date the payment date Month and year
Monday
Tue sday
Wedne sday
Thursday
Friday
Saturday
Sunday
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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.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
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The Record Date...
The date ownership of the outstanding shares is
determined for dividend purposes. Dec 20
No Entry Necessary.
The date dividend checks are mailed.January 20 is the payment date for Media General.
Jan 20 Dividends Payable 50,000Cash 50,000
The Payment Date...
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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.
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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.
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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.
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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.
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Stock Split
Because a stock split does not affect the balances in stockholders' equity accounts, it is not necessary to journalize a stock split.
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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.
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ReviewReview
Vista, Inc. had 300,000 shares of common stock outstanding Vista, Inc. had 300,000 shares of common stock outstanding when a 30% stock dividend was declared and issued. How many when a 30% stock dividend was declared and issued. How many
shares were outstanding after the stock dividend?shares were outstanding after the stock dividend?
a.a. 390,000390,000
b.b. 330,000330,000
c.c. 300,000300,000
d.d. 309,000309,000
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ReviewReview
Vista, Inc. had 300,000 shares of common stock outstanding Vista, Inc. had 300,000 shares of common stock outstanding when a 30% stock dividend was declared and issued. How many when a 30% stock dividend was declared and issued. How many
shares were outstanding after the stock dividend?shares were outstanding after the stock dividend?
a.a. 390,000390,000
b.b. 330,000330,000
c.c. 300,000300,000
d.d. 309,000309,000
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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.
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Deficit
Is a debit balance in retained earnings and is reported as a deduction in the stockholders' equity section of the balance sheet.
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Retained Earnings Restrictions...
Are legal, contractual or voluntary circumstances that make a portion of retained earnings currently unavailable for dividends.
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Stockholders’ Equity with Deficit
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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.
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Return on Common Stockholders’ Equity Ratio =
NET INCOME - PREFERRED STOCK DIVIDENDSAVERAGE COMMON STOCKHOLDERS’ EQUITY
...measures the profitability from the stockholders’ point of view.
Advantages of Bond Financing Over Common Stock
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Relationship of Par and No-Par Value to Legal Capital
Stock Legal Capital PerShare
Par value Par value
No-par value withstated value
Stated value
No-par valuewithout statedvalue
Entire proceeds
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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
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ReviewReview
Roger is nearing retirement and would like to invest in a stock Roger is nearing retirement and would like to invest in a stock that will provide a good steady income supply. Roger should that will provide a good steady income supply. Roger should choose a stock with a:choose a stock with a:
a) high current ratio.a) high current ratio.
b) high dividend payout.b) high dividend payout.
c) high earnings per share.c) high earnings per share.
d) high price-earnings ratio.d) high price-earnings ratio.
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ReviewReview
Roger is nearing retirement and would like to invest in a stock Roger is nearing retirement and would like to invest in a stock that will provide a good steady income supply. Roger should that will provide a good steady income supply. Roger should choose a stock with a:choose a stock with a:
a) high current ratio.a) high current ratio.
b) high dividend payout.b) high dividend payout.
c) high earnings per share.c) high earnings per share.
d) high price-earnings ratio.d) high price-earnings ratio.
C O P Y R I G H T
C o p y r i g h t © 2 0 0 7 , J o h n W i l e y & S o n s , I n c . A l l r i g h t s r e s e r v e d . R e p r o d u c t i o n o r t r a n s l a t i o n o f t h i s w o r k b e y o n d t h a t p e r m i t t e d i n S e c t i o n 1 1 7 o f t h e 1 9 7 6 U n i t e d S t a t e s C o p y r i g h t A c t w i t h o u t t h ee x p r e s s w r i t t e n p e r m i s s i o n o f t h e c o p y r i g h t o w n e r i s u n l a w f u l . R e q u e s t f o r f u r t h e r i n f o r m a t i o n s h o u l d b e a d d r e s s e d t o t h e P e r m i s s i o n s D e p a r t m e n t , J o h n W i l e y & S o n s , I n c . T h e p u r c h a s e r m a y m a k e b a c k - u p c o p i e s f o r h i s / h e r o w n u s e o n l y a n d n o t f o r d i s t r i b u t i o n o r r e s a l e . T h e P u b l i s h e r a s s u m e s n o r e s p o n s i b i l i t yf o r e r r o r s , o m i s s i o n s , o r d a m a g e s , c a u s e d b y t h e u s e o f t h e s e p r o g r a m s o r f r o m t h e u s e o f t h e i n f o r m a t i o n c o n t a i n e d h e r e i n .