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.

Other Forms of Business Organization Limited partnerships Limited liability partnerships (LLPs) Limited liability companies (LLCs) S Corporation No double taxation. Cannot have more than 75 shareholders. LO 1 Identify and discuss the major characteristics of a corporation.

The Corporate Form of Organization Forming a Corporation Initial Steps: File application with the Secretary of State. State grants charter. Corporation develops by-laws. Companies generally incorporate in a state whose laws are favorable to the corporate form of business (Delaware, New Jersey). Corporations engaged in interstate commerce must obtain a license from each state in which they do business. 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 Authorized Stock Charter indicates the amount of stock that a corporation is authorized to sell. Number of authorized shares is often reported in the stockholders’ equity section. LO 2 Record the issuance of common stock.

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.

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.

Stock Issue Considerations Par and No-Par Value Stocks Capital stock that has been assigned a value per share. Years ago, par value determined the legal capital per share that a company must retain in the business for the protection of corporate creditors. Today many states do not require a par value. No-par value stock is fairly common today. In many states the board of directors assigns a stated value to no-par shares. 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. Total amount of stock that has been issued or sold to stockholders. 11-12

Stock Issue Considerations Common Stock Account Paid-in Capital Paid-in Capital in Excess of Par Account Preferred Stock Account Two Primary Sources of Equity Retained Earnings Account Paid-in capital is the total amount of cash and other assets paid in to the corporation by stockholders in exchange for shares of ownership. LO 2 Record the issuance of common stock.

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.

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.

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 11-19

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

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 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 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.

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 Stock Dividends Pro rata distribution of the corporation’s own stock. Illustration 11-10 Results in decrease in retained earnings and increase in paid-in capital. LO 5 Prepare the entries for cash dividends and understand the effect of stock dividends and stock splits.

Dividends Effects of Stock Dividends Changes the composition of stockholders’ equity. Total stockholders’ equity remains the same. No effect on the par or stated value per share. Increases the number of shares outstanding. LO 5 Prepare the entries for cash dividends and understand the effect of stock dividends and stock splits.

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.

Dividends Illustration: Assuming Medland splits its 50,000 shares of common stock on a 2-for-1 basis. Illustration 11-11 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