Accounting, Fifth Edition 11 REPORTING AND ANALYZING STOCKHOLDERS’ EQUITY Accounting, Fifth Edition

Learning Objectives After studying this chapter, 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. 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.* *Self-study topics

Characteristics of a Corporation Characteristics that distinguish corporations from proprietorships and partnerships. Separate Legal Existence Limited Liability of Stockholders Transferable Ownership Rights Ability to Acquire Capital Continuous Life Corporate Management Government Regulations Additional Taxes Advantages Disadvantages LO 1 Identify the major characteristics of a corporation.

The Corporate Form of Organization Stockholders usually meet once a year. Ultimate control. Stockholders Selected by a vote of the stockholders. Chairman and Board of Directors Overall responsibility for managing the company. President and Chief Executive Officer General Counsel/ Secretary Vice President Marketing Vice President Finance/Chief Financial Officer Vice President Operations/Chief Operating Officer Vice President Human Resources Treasurer Controller Illustration 11-1 Corporation organization chart LO 1 Identify and discuss the major characteristics of a corporation.

Different Ways to Finance a Company Borrowing from a Bank (Ch 10): Notes Payable – More expensive and restrictive than bonds. Selling Stock (Ch 11): Gives up ownership shares, but does NOT require interest or principal repayments. Issuing Bonds (Ch 10): Easier to deal with than bank loans, require interest & principal repayment.

Stock Issue Considerations Issuance of Stock Corporation can issue common stock directly to investors or indirectly through an investment banking firm. Top five exchanges by value of shares traded: New York Stock Exchange Nasdaq stock market London Stock Exchange Tokyo Stock Exchange Euronext LO 2 Record the issuance of common stock.

Looking at Facebook’s IPO in May 2012 http://www.youtube.com/watch?v=zEXhNVDN-OI Facebook Made “Strategic Mistake” with IPO, says Mark Cuban https://www.youtube.com/watch?v=jArZ_qppJAo

Facebook’s Stock Price History

Stockholders’ Rights 1. Vote in election of board of directors and on actions that require stockholder approval. 2. Share the corporate earnings through receipt of dividends. 3. Keep the same percentage ownership when new shares of stock are issued (preemptive right). 4. Share in assets upon liquidation in proportion to their holdings. This is called a residual claim. LO 1 Identify and discuss the major characteristics of a corporation.

Par & No-Par Value Stocks Par Value stock - Capital stock that has been assigned a value per share and establishes minimum legal capital. Today many states do not require a par value. No-par value stock – no assigned value. Stated Value – No-par value stock that is later assigned a stated value by the board of directors. LO 2 Record the issuance of common stock.

Basics of Capital Stock Total amount of stock that a corporation’s charter authorizes it to sell. Corporations must disclose information related to their stock, such as par value and number of shares authorized and issued. The corporate charter determines the number of shares of stock the corporation is authorized to sell. We can also find the number of shares actually issued by the company. In our example, the company had issued a total of ninety two million, five hundred fifty-six thousand, two hundred ninety-five shares by the end of 2009. Notice that this common stock has a par value of one cent. Low par values are normal in business. Let’s look at the meaning of par value. Total amount of stock that has been issued or sold to stockholders. 11-11

Accounting for Common Stock Issuances Illustration: Assume that Hydro-Slide, Inc. issues 2,000 shares of $1 par value common stock. Prepare Hydro-Slide’s journal entry if (a) 1,000 share are issued for $1 per share, and (b) 1,000 shares are issued for $5 per share. Cash 1,000 Common stock (1,000 x $1) 1,000 Cash 5,000 Paid-in capital in excess of par value 4,000 a) b) LO 2 Record the issuance of common stock.

RISK Risk Analysis of Corporate Investments Common Stock Voting Rights Dividends, back of line Preferred Stock No voting rights Dividends, front of line Non-cumulative Cumulative RISK Bonds Payable – Lender/Borrower

Preferred Stock Typically, preferred stockholders have a priority in relation to dividends and assets in the event of liquidation. However, they sometimes do not have voting rights. Each paid-in capital account title should identify the stock to which it relates: Paid-in Capital in Excess of Par Value—Preferred Stock Paid-in Capital in Excess of Par Value—Common Stock LO 4 Differentiate preferred stock from common stock.

Preferred Stock Illustration: Stine Corporation issues 10,000 shares of $10 par value preferred stock for $12 cash per share. Journalize the issuance of the preferred stock. Cash 120,000 Preferred stock (10,000 x $10) 100,000 Paid-in capital in excess of par – Preferred stock 20,000 Preferred stock may have a par value or no-par value. LO 4 Differentiate preferred stock from common stock.

Preferred Stock Dividend Preferences Right to receive dividends before common stockholders. Per share dividend amount is stated as a percentage of the preferred stock’s par value or as a specified amount. Cumulative dividend – holders of preferred stock must be paid their annual dividend plus any dividends in arrears before common stockholders receive dividends. LO 4 Differentiate preferred stock from common stock.

Preferred Stock – Cumulative vs Non-Cumulative Dividends If the preferred stock is noncumulative, these stockholders have no rights to the missed dividends of the year 2009. However, they get first distribution of the dividends declared in 2010. The dividend for the preferred stock in 2009 is calculated as follows: one hundred dollar par value times nine percent times one thousand shares. Since forty two thousand dollars in dividends were declared, preferred would first get their nine thousand dollars, and the remaining thirty three thousand dollars would be divided evenly among the common stockholders. If the preferred stock is cumulative, these stockholders have rights to the missed dividends of 2009 in addition to the dividend in 2010. The preferred stockholders first get a distribution of nine thousand dollars for the missed dividends of 2009. Then they get another nine thousand dollars for the dividend in 2010. Since forty two thousand dollars in dividends were declared, preferred would first get their eighteen thousand dollars and the remaining twenty four thousand dollars would be divided evenly among the common stockholders. An additional preference for preferred stock is participation in dividends if they are declared above certain limits. This participation feature does not apply until common stockholders receive dividends equal to the preferred stock’s dividend percent. This is not a common preference seen in practice. 11-17

Stock Issue Considerations Stockholders’ equity section assuming Hydro-Slide, Inc. has retained earnings of $27,000. Illustration 11-5 LO 2 Record the issuance of common stock.

Common & Preferred Stock Practice Problem June 12 & July 11 transactions only

Accounting for Treasury Stock Treasury stock - corporation’s own stock that it has reacquired from shareholders, but not retired. Corporations purchase their outstanding stock: To reissue shares to officers and employees under bonus and stock compensation plans. To increase trading of the company’s stock in the securities market. To have additional shares available for use in acquiring other companies. To increase earnings per share. Another infrequent reason is to eliminate hostile shareholders. LO 3 Explain the accounting for the purchase of treasury stock.

Accounting for Treasury Stock Purchase of Treasury Stock Generally accounted for by the cost method. Debit Treasury Stock for the price paid. Treasury stock is a contra stockholders’ equity account, not an asset. Normal side is a DEBIT. Treasury Stock decreases by the same amount when the company later sells the shares. LO 3 Explain the accounting for the purchase of treasury stock.

Accounting for Treasury Stock Illustration 11-6 Illustration: On February 1, 2014, Mead acquires 4,000 shares of its stock at $8 per share. Prepare the entry. Treasury stock (4,000 x $8) 32,000 Cash 32,000 LO 3 Explain the accounting for the purchase of treasury stock.

Accounting for Treasury Stock Illustration: On June 1, 2014, Mead sells 2,000 shares of its stock at $12 per share. Prepare the entry. Cash (2,000 x $12) 24,000 Treasury Stock (2,000 x $8) 16,000 APIC - Treasury Stock (2,000 x [$12-$4]) 8,000 LO 3 Explain the accounting for the purchase of treasury stock.

Accounting for Treasury Stock Stockholders’ Equity with Treasury stock Illustration 11-7 Both the number of shares issued (100,000), outstanding (96,000), and the number of shares held as treasury (4,000) are disclosed. LO 3 Explain the accounting for the purchase of treasury stock.

Common & Preferred Stock Practice Problem Nov 28th only

Dividends http://www.youtube.com/watch?v=fkO-NxhMn50

Dividends A distribution to stockholders on a pro rata (proportional to ownership) basis. Types of Dividends: Cash dividends. Property dividends. Stock dividends. Scrip (promissory note) LO 5 Prepare the entries for cash dividends and understand the effect of stock dividends and stock splits.

Dividends Cash Dividends For a corporation to pay a cash dividend, it must have: Retained earnings - Payment of dividends from retained earnings is legal in all states. Adequate cash. Declaration by the Board of Directors. LO 5 Prepare the entries for cash dividends and understand the effect of stock dividends and stock splits.

Dividends Dividends require information concerning three dates: LO 5 Prepare the entries for cash dividends and understand the effect of stock dividends and stock splits.

Dividends Illustration: On Dec. 1, 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 payable on Jan. 20 to shareholders of record on Dec. 22: December 1 (Declaration Date) Cash dividends 50,000 Dividends payable 50,000 December 22 (Record Date) No entry January 20 (Payment Date) Dividends payable 50,000 Cash 50,000 LO 5 Prepare the entries for cash dividends and understand the effect of stock dividends and stock splits.

Dividends Review Question Entries for cash dividends are required on the: declaration date and the record date. record date and the payment date. declaration date, record date, and payment date. declaration date and the payment date. LO 5 Prepare the entries for cash dividends and understand the effect of stock dividends and stock splits.

Do it! 11-4, p 605

Stock Splits Reduces the market value of shares. No entry recorded for a stock split. Decrease par value and increase number of shares. LO 5 Prepare the entries for cash dividends and understand the effect of stock dividends and stock splits.

Retained Earnings Statement Statement shows amounts and causes of changes in retained earnings during the period. Time period is the same as that covered by the income statement. Users can evaluate dividend payment practices. Retained earnings is part of the stockholders’ claim on the total assets of the corporation. A debit balance in Retained Earnings is identified as a deficit. Retained Earnings Statement Illustration 1-5 Helpful Hint The heading of this statement identifies the company, the type of statement, and the time period covered by the statement. LO 4 Describe the content and purpose of each of the financial statements.

Retained Earnings Illustration 11-14 LO 6 Identify the items that affect retained earnings.

Retained Earnings Retained Earnings Restrictions Restrictions can result from: Legal restrictions. Contractual restrictions. Voluntary restrictions. Illustration 11-15 Disclosure of unrestricted retained earnings LO 6 Identify the items that affect retained earnings.

Presentation of Stockholders’ Equity Balance Sheet Presentation Illustration 11-16 Two classifications of paid-in capital: * Capital stock * Additional paid-in capital LO 7 Prepare a comprehensive stockholders’ equity section.

Measuring Corporate Performance Dividend Record Illustration: The following is the calculation of the payout ratio for Nike in 2011 and 2010. Illustration 11-18 The payout ratio measures the percentage of earnings a company distributes in the form of cash dividends. LO 8 Evaluate a corporation’s dividend and earnings performance from a stockholder’s perspective.

Measuring Corporate Performance Earnings Performance Illustration: The following is the calculation of Nike’s return on common stockholders’ equity ratios for 2011 and 2010. Illustration 11-20 This ratio shows how many dollars of net income a company earned for each dollar of common stockholders’ equity. LO 8 Evaluate a corporation’s dividend and earnings performance from a stockholder’s perspective.

Measuring Corporate Performance Debt Versus Equity Decision Illustration 11-21 LO 8 Evaluate a corporation’s dividend and earnings performance from a stockholder’s perspective.

Measuring Corporate Performance Debt Versus Equity Decision Illustration 11-22 LO 8 Evaluate a corporation’s dividend and earnings performance from a stockholder’s perspective.

Measuring Corporate Performance Illustration: Microsystems Inc. currently has 100,000 shares of common stock outstanding issued at $25 per share and no debt. It is considering two alternatives for raising an additional $5 million: Plan A involves issuing 200,000 shares of common stock at the current market price of $25 per share. Plan B involves issuing $5 million of 12% bonds at face value. Income before interest and taxes will be $1.5 million; income taxes are expected to be 30%. Illustration 11-23 LO 8

Options are given to key employees to motivate them to: Measuring Corporate Performance Options are given to key employees to motivate them to: focus on company performance, take a long-run perspective, and remain with the company. Stock options give the owner the right to purchase common stock at a fixed price over a specified period of time. As the stock’s price rises above the fixed option price, the value of the option increases. Corporations give stock options to motivate employees to focus on the company’s stock performance, to take a long-run perspective, and to remain with the company. 11-46

Issuing Stock for Services https://www.youtube.com/watch?v=MtazR6Iu2yE