SHAREHOLDERS’ SHAREHOLDERS’ EQUITYEQUITY

Chapter 18

© 2009 The McGraw-Hill Companies, Inc.

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The Nature of Shareholders’ Equity The Nature of Shareholders’ Equity

Assets – Liabilities = Shareholders’ Equity

Shareholders’ Equity

Paid-in Capital

Retained Earnings

Amounts earnedby corporation

Amounts investedby shareholders

Accumulated OtherComprehensive Income

Other gains and losses not included in net income

Sources ofShareholders’

Equity

Net Assets

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Slide 3Slide 3

The Corporate OrganizationThe Corporate Organization

ContinuousExistence

Easy ownership

transfer

Limitedliability

Easy toraise capital

Disadvantages of a corporation

Advantages of a corporation

Doubletaxation

Governmentregulation

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Types of CorporationsTypes of Corporations

Not-for-profit corporations includehospitals, charities, and governmentagencies such as FDIC.

Privately-held corporationswhose shares are owned by only a few individuals.

Publicly-held corporationswhose shares are widelyowned by the general public.

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Hybrid OrganizationsHybrid Organizations

S Corporation• Limited liability protection of a corporation. • Maximum number of owners.

Limited liability company• Limited liability protection of a corporation.• All owners may be involved in management

without losing limited liability protection.

• No limit on number of owners.Limited liability partnership

• Owners are liable for their own actions but not entirely liable for actions of other partners.

S Corporation• Limited liability protection of a corporation. • Maximum number of owners.

Limited liability company• Limited liability protection of a corporation.• All owners may be involved in management

without losing limited liability protection.

• No limit on number of owners.Limited liability partnership

• Owners are liable for their own actions but not entirely liable for actions of other partners.

Doubletaxationavoided.

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Board of directors appoint officers.

The Model Business Corporation ActThe Model Business Corporation Act

Articles of incorporationare filed with the state.

Board of directors elected by

shareholders.Shares of

stock issued.

State issues a corporate charter.

CorporateCharter

• Nature and location of business activities.• Number and classes of shares authorized.• Number and classes of shares authorized.

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Fundamental Share RightsFundamental Share Rights

Rightto vote.

Right to sharein distribution of

assets if companyis liquidated.

Right to sharein profits whendividends are

declared.

Preemptiveright to maintain

percentageownership.

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Issued shares are authorized shares of stock that have been

sold.

Unissued shares are authorized shares of stock that

never have been sold.

Authorized shares are the maximumnumber of shares of capital stock that

can be sold to the public.

Authorized, Issued, and Outstanding SharesAuthorized, Issued, and Outstanding Shares

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AuthorizedShares

UnissuedShares

TreasuryShares

OutstandingSharesIssued

SharesTreasury shares are issued shares that

have been reacquired by the corporation.

Outstanding shares are issued shares that are

owned by stockholders.

Authorized, Issued, and Outstanding SharesAuthorized, Issued, and Outstanding Shares

RetiredShares

Retired shares have the same

status as authorized but

unissued shares.

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Capital StockCapital StockPar value stock

Dollar amount per share is stated in the corporate charter.

Par value has no relationship to market value.

No-par stock Dollar amount per share

is not designated in corporate charter.

Corporations can assign a stated value per share (treated as if par value).

Legal capital is . . . The portion of shareholders’ equity that must be

contributed to the firm when stock is issued. The amount of capital, required by state law, that must

remain invested in the business. Refers to par value, stated value, or full amount paid for

no-par stock.

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Capital StockCapital StockCommon stock is the basic voting stock of the

corporation. It ranks after preferred stock for dividend and liquidation distribution. Dividends are determined

by the board of directors.

Dividend and liquidation preference overcommon stock.

Generally does nothave voting rights.

Usually has apar or stated value.

May be convertible,callable, and/or

redeemable.

PreferredStock

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Slide 12Slide 12

Preferred Stock DividendsPreferred Stock Dividends

Unpaid dividends must be paid in full beforeany distributions to common stock.

Dividends in arrears are not liabilities, but the pershare and aggregate amounts must be disclosed.

• Are usually stated as a percentage of the par or stated value.

• May be cumulative or noncumulative.

• May be partially participating, fully participating, or nonparticipating.

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Comprehensive IncomeComprehensive Income

Deferred gains (losses) from derivatives.

Deferred gains (losses) from derivatives.

Gains (losses) from and

amendments to post retirement benefit plans.

Gains (losses) from and

amendments to post retirement benefit plans.

Gains (losses) from foreign

currency translations.

Gains (losses) from foreign

currency translations.

Comprehensive income includes four typesof gains and losses that traditionally have

been excluded from net income.

Comprehensive income includes four typesof gains and losses that traditionally have

been excluded from net income.

Net holding gains (losses)

on investments.

Net holding gains (losses)

on investments.

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Comprehensive income is reported periodically as it is created and also is reported as a cumulative amount.

Comprehensive income is reported periodically as it is created and also is reported as a cumulative amount.

Comprehensive IncomeComprehensive Income

There are 3 options for reporting comprehensive income created during the

reporting period.

There are 3 options for reporting comprehensive income created during the

reporting period.

The accumulated amount of comprehensive income is reported as a separate

item of shareholders’ equity in the balance sheet.

The accumulated amount of comprehensive income is reported as a separate

item of shareholders’ equity in the balance sheet.

As a separate statement.

As a separate statement.

As an additional section of the

income statement.

As an additional section of the

income statement.

As part of the statement of

shareholders’ equity.

As part of the statement of

shareholders’ equity.

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Shares Issued for CashShares Issued for Cash10,000 shares of stock are issued for $100,000 cash.

$1 Par Value

No ParValue

No Par,$1 Stated

Value

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Issuing Stock for Noncash AssetsIssuing Stock for Noncash Assets

Apply the general valuation principle by using fair value of stock given up or fair value of asset received, whichever is more clearly

evident.

If market values cannot be determined, use appraised values.

Apply the general valuation principle by using fair value of stock given up or fair value of asset received, whichever is more clearly

evident.

If market values cannot be determined, use appraised values.

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More Than One Security IssuedMore Than One Security Issuedfor a Single Pricefor a Single PriceAllocate the lump-sum received based on the relative fair

values of the two securities. If only one fair value is known, allocate a portion of the

lump-sum received based on that fair value and allocate the remainder to the other security.

Toys, Inc. issued 5,000 shares of common stock, $10 par value and 3,000 shares of preferred stock, $5 par value for $450,000. The market values of the common stockand preferred stock were $55 and $75, respectively.

Calculate the additional paid-incapital for each class of stock.

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Market* % Allocation** Par^ Excess^^Common Stock 275,000$ 55% 247,500$ 50,000$ 197,500$ Preferred Stock 225,000 45% 202,500 15,000 187,500

Total 500,000$ 100% 450,000$ 65,000$ 385,000$

* Market Value: ^ Par Value: Common: $55 × 5,000 shares Common: $10 × 5,000 shares Preferred: $75 × 3,000 shares Preferred: $5 × 3,000 shares

**Allocation: ^^Excess: Common: $450,000 × 55% Common: $247,500 - $50,000 par Preferred: $450,000 × 45% Preferred: $202,500 - $15,000 par

More Than One Security IssuedMore Than One Security Issuedfor a Single Pricefor a Single Price

GENERAL JOURNAL Page 1

Date Description PR Debit Credit

Cash 450,000 Common Stock, par $10 50,000 Preferred Stock, par $5 15,000 Additional paid-in capital, Common Stock 197,500 Additional paid-in capital Preferred Stock 187,500

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Share Issue CostsShare Issue Costs

Share issue costs reduce net proceedsfrom selling shares, resulting in a loweramount of additional paid-in capital.

• Registration fees• Underwriter commissions• Printing and clerical costs• Legal and accounting fees• Promotional costs

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Slide 20Slide 20

Share BuybacksShare Buybacks A corporation might reacquire shares of its stock to . . .

• support the market price.

• increase earnings per share.

• distribute in stock option plans.

• issue as a stock dividend.

• use in mergers and acquisitions.

• thwart takeover attempts.

A corporation might reacquire shares of its stock to . . .

• support the market price.

• increase earnings per share.

• distribute in stock option plans.

• issue as a stock dividend.

• use in mergers and acquisitions.

• thwart takeover attempts.

I can account for the reacquired shares by retiring them or by holding

them as treasury shares.

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Accounting for Retired SharesAccounting for Retired Shares

When shares are formally retired, we reduce the same capital accounts that were increased when the shares were issued –

common or preferred stock, and additional paid-in capital.

5,000 shares of $2 par value stock that were issuedfor $20 per share are reacquired for $17 per share.

Price paid is less than issue price.

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Slide 22Slide 22

Price paid is more than issue price.

Accounting for Retired SharesAccounting for Retired Shares

Reduce Retained Earnings if the Paid-in Capital – Share Repurchase account balance is insufficient.

5,000 shares of $2 par value stock that were issuedfor $20 per share are reacquired for $25 per share.

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Accounting for Treasury StockAccounting for Treasury Stock

Acquisition of Treasury Stock•Recorded at cost to acquire.

Resale of Treasury Stock•Treasury Stock credited for cost.•Difference between cost and issuance price is (generally) recorded in paid-in capital – share repurchase.

Treasury stock usually does not have:

•Voting rights.

•Dividend rights.

•Preemptive rights.

•Liquidation rights.Treasury stock is reported as an unallocated reductionof total Shareholders’ Equity.

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On 5/1/08, Photos-in-a-Second reacquired 3,000 shares of its common stock at $55 per share. On 12/3/09, Photos-in-a-Second reissued 1,000 shares of the stock at $75 per share. Which of the following would be included in the 12/3/09 entry?a. Credit Cash for $165,000.b. Debit Treasury Stock for $75,000.c. Credit Treasury Stock for $55,000.d. Credit Cash for $75,000.

Accounting for Treasury StockAccounting for Treasury Stock

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Retained EarningsRetained Earnings

Represents the undistributed earnings of the company since its inception.

Balance January 1, 2009 $ 106,500 Net income 25,000 Cash dividends (10,000) Balance December 31, 2009 121,500$

The statement of retained earnings may also contain the correction of an accounting error that occurred in the financial statements of a prior period, called a prior period adjustment.

Any restrictions on retained earnings must be disclosed in the notes to the financial statements.

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Example: Shareholders’ EquityExample: Shareholders’ EquitySection of a Balance SheetSection of a Balance Sheet

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Accounting for Cash DividendsAccounting for Cash Dividends

Declared by board of directors.

Not legally required.

Creates liability at declaration.

Requires sufficient Retained Earnings and

Cash.

Declaration date• Board of directors declares the dividend.

• Record a liability.

Date Description Debit Credit

Retained Earnings XXX

Dividends Payable XXX

GENERAL JOURNAL

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Date of Record Stockholders holding shares on this date will receive

the dividend. (No entry)

Dividend DatesDividend Dates

Date of PaymentRecord the dividend payment to stockholders.

Date Description Debit Credit

Dividends Payable XXX

Cash XXX

GENERAL JOURNAL

Ex-dividend date The first day the shares trade without the right to

receive the declared dividend. (No entry)

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Property DividendsProperty Dividends

Distributions of non-cash assets.

Record at fair value of non-cash asset.

Recognize gain or loss for difference between book value and fair value.

Distributions of non-cash assets.

Record at fair value of non-cash asset.

Recognize gain or loss for difference between book value and fair value.

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Accounting for Stock DividendsAccounting for Stock Dividends

Distribution of additional shares of stock to owners.

No change in total stockholders’ equity.

All stockholders retain same percentage ownership.

No change inpar values.

Stock dividend < 25%Stock dividend < 25%

Record at current fairvalue of stock.

Record at current fairvalue of stock.

SmallStock dividend > 25%Stock dividend > 25%

Record at parvalue of stock.Record at parvalue of stock.

Large

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GENERAL JOURNAL Page 21

Date DescriptionPost. Ref. Debit Credit

Retained Earnings 20,000,000

Common Stock 1,000,000

Paid-in Capital in

Excess of Par 19,000,000

CarCo declares and distributes a 20% stock dividend on 5 million common

shares. Par value is $1 and market value is $20. Prepare the required journal entry.

Accounting for Stock DividendsAccounting for Stock Dividends

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Stock splits change the par value per share and the number of shares outstanding, but the total par value is

unchanged, and no journal entry is required.

Stock SplitsStock Splits

Assume that a corporation had 3,000shares of $2 par value common stock outstanding

before a 2–for–1 stock split.

Increase

Decrease

No Change

Before Split

After Split

Common Stock Shares 3,000 6,000

Par Value per Share 2.00$ 1.00$

Total Par Value 6,000$ 6,000$

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Stock Splits Effected in theStock Splits Effected in theForm of Large Stock DividendsForm of Large Stock Dividends

Matrix, Inc. declares and distributes a 2-for-1 stock split effected in the form of a 100% stock dividend.

The company has 1,000,000, $1 par value common stock outstanding. The stock is trading in the open

market for $14 per share. The per share par value of the shares is not to be changed.

Matrix, Inc. declares and distributes a 2-for-1 stock split effected in the form of a 100% stock dividend.

The company has 1,000,000, $1 par value common stock outstanding. The stock is trading in the open

market for $14 per share. The per share par value of the shares is not to be changed.

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Appendix 18 ─ Quasi ReorganizationsAppendix 18 ─ Quasi ReorganizationsPurpose

To allow a company undergoing financial difficulty, but with favorable future prospects, to get a fresh start by writing

down inflated assets and eliminating an accumulated balance in retained earnings.

Procedures

• Assets and liabilities are revalued to reflect market values, with corresponding debits and credits to retained earnings.

• The debit balance in retained earnings is eliminated first against additional paid in capital, and then, if necessary, against common stock.

• Retained earnings is dated to indicate when the new accumulation of earnings began.

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Emerson-Walsch Corporation has incurred losses for several years. The board of directors voted to implement a

quasi reorganization, subject to shareholder approval. The balance sheet prior to restatement, in millions, follows :

Quasi ReorganizationsQuasi Reorganizations

(millions)Cash 75$ Receivables 200 Inventory 375 Property, plant, and equipment (net) 400 Total assets 1,050$

Liabilities 400$ Common stock (800 million shares @$1) 800 Additional paid-in capital 150 Retained earnings (deficit) (300) Total liabilities and equity 1,050$

Fair values: Inventory =

$300,000,000 and Property,

plant, and equipment =

$225,000,000.

Let’s prepare the journal entries necessary for the quasi reorganization.

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GENERAL JOURNAL Page 43

Date DescriptionPost. Ref. Debit Credit

Retained Earnings 250

Inventory 75

Property, plant, & equipment 175

To revalue assetsQuasi ReorganizationsQuasi Reorganizations

GENERAL JOURNAL Page 43

Date DescriptionPost. Ref. Debit Credit

Additional paid-in capital 150

Common stock 400

Retained earnings 550

To eliminate the deficit in retained earnings

$300 + $250

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Cash 75$ Receivables 200 Inventory 300 Property, plant, and equipment (net) 225 Total assets 800$

Liabilities 400$ Common stock (800 million shares @$.50) 400 Additional paid-in capital 0Retained earnings 0 Total liabilities and equity 800$

Balance sheet immediately after restatement.Balance sheet immediately after restatement.

Quasi ReorganizationsQuasi Reorganizations

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End of Chapter 18End of Chapter 18

© 2008 The McGraw-Hill Companies, Inc.