Shareholders’ Equity Sid Glandon, DBA, CPA Associate Professor of Accounting The University of Texas at El Paso

Components of Equity  Contributed capital –Capital stock  Preferred stock  Common stock –Additional paid-in capital  Preferred stock  Common stock  Retained earnings  Less: treasury stock  Total shareholders’ equity

Corporate Form  Governed by state corporation law  Capital stock or share system  Multiple ownership interests  Limited liability of stockholders  Formality of profit distribution

Preferred Stock  Preference as to –Dividends –Assets in liquidation  Nonvoting  Stated at par with dividend expressed as a percentage of par

Features of Preferred Stock  Cumulative preferred stock –Dividends in arrears  Participating preferred stock –Fully participating –Partially participating  Convertible preferred stock  Callable preferred stock –Dividends in arrears must be paid first

Issuance of Common Stock  Par value stock  No-par stock (stated value)  Stock sold for cash  Stock sold on contract  Stock exchanged for services, etc.  Lump sum sales of securities  Stock issue costs

Reacquisition of Shares  Provide tax efficient distributions  Increase EPS and ROE  Provide stock –Employee stock compensation contracts –Potential mergers needs  Thwart takeover attempts –Reduce the number of shareholders  Make a market for the stock

Treasury Stock  Reacquired stock not retired  Not an asset  Issued but not outstanding  Purchase of treasury stock –Cost method –Par or stated value method

Cost Method of Recording Treasury Stock

Additional Paid-In Capital, Treasury Stock  When credit balance is eliminated, excess of cost over selling price is debited to retained earnings.

Treasury Stock Account  Contra equity account –Cost method record full cost of stock  Subtract treasury stock from total stockholders equity  Reduces the number of outstanding shares

Retiring Treasury Stock  Authorized but not issued  Journal entry similar to sale except the debit is to additional paid-in capital from retirement of treasury stock

Cost Method: Retirement of Treasury Stock

Retained Earnings  Debits –Net loss –Cash dividends –Property dividends –Stock dividends –Loss on treasury stock transactions –Prior period adjustments  Credits –Net income –Prior period adjustments –Adjustments due to quasi-reorganization

Dividend Policy  Restricted by debt covenants  Limited by state corporation laws  Internal financing-reinvest earnings  Smooth out dividend payments  Build up cushion for future  Availability of funds to pay dividends  No dividends paid on treasury stock

Types of Dividends  Cash dividends  Property dividends  Scrip dividends (deferred)  Liquidating dividends (return of capital)  Stock dividends (do not reduce total stockholders equity)

Cash Dividends  Declaration date –Date dividends are declared and accrued  Date of record –List of recipient stockholders is final  Payment date –Dividends are paid to stockholders of record

Cash Dividends: Example  10,000 shares issued and outstanding –June 10, 2005 declared a $1 dividend –June 24, 2005 date of record –July 16, 2005 paid dividends

Journal Entries: Cash Dividends

Property Dividends  Payable in nonmonetary assets  Non-reciprocal transfers  Valued at FMV at date of declaration  Corporation recognizes gain or loss

Property Dividends: Example  Company distributes marketable securities as a property dividend –Date of declaration: December 21, 2004 –Date of record: January 14, 2005 –Date of payment: January 21, 2005  FMV of securities –December 21, 2004, $134,000 –January 21, 2005, $135,900  Cost of securities: $110,000

Journal Entries: Property Dividends

Liquidating Dividends  Return of corporate paid-in capital  Reduces paid-in capital  Corporation winding up operations  Dividends are specified as to income (regular) and capital (liquidating) portions

Liquidating Dividends: Example  December 30, 2004, declared a dividend of $1,200,000 –Income portion $900,000 –Capital portion $300,000  January 15, 2005, paid dividend of $1,200,000

Journal Entries: Liquidating Dividends

Stock Dividends  Results in more shares issued  Ordinary (small) stock dividends –Issue of less than 20%-25% of stock –Accounting is based on FMV  Large stock dividends –Issue of more than 20%-25% of stock –Accounting is based on par value

Ordinary Stock Dividends: Example  Issued and outstanding stock: 1,000 shares, $10 par value  April 1, 2005 –10% stock dividend declared (100 shares) –$12 per share FMV at date of declaration  May 1, 2005 –Stock dividends paid

Journal Entries: Ordinary Stock Dividends

Large Stock Dividends: Example  Issued and outstanding stock: 3,000 shares, $10 par value  April 1, 2004 –30% stock dividend declared (900 shares) –$12 per share FMV on date of declaration  May 1, 2005 –Stock dividends paid

Journal Entries: Large Stock Dividends

Stock Splits  Par value decreases  Number of shares increases  Stockholders’ equity does not change  Composition of equity does not change  No formal journal entry  Splits make shares less expensive