Equity Financing - Learning Objectives 1. Identify the rights associated with ownership of common and preferred stock. 2. Record the issuance of stock for cash, on a subscription basis, and in exchange for noncash assets or for services. 3. Use both the cost and par value methods to account for stock repurchases. Account for the issuance of stock rights and stock warrants. Explain the difference between the intrinsic value and fair value methods, and use both in accounting for a fixed stock option plan. 6. Distinguish between stock conversions that require a reduction in retained earnings and those that do not. 7. List the factors that impact the retained earnings balance.

Learning Objectives 8. Properly record cash dividends, property dividends, small and large stock dividends, and stock splits. 9. Explain the background of unrealized gains and losses recorded as direct equity adjustments, and list the major types of equity reserves founds in foreign balance sheets. 10. Prepare a statement of changes in stockholders’ equity.

Common Stock The owners of common stock of a corporation can be thought of as the true owners of the business. Unless restricted by terms of the articles of incorporation, the common stockholder has certain basic rights.

Common Stock The right to vote in the election of directors and in the determination of certain corporate polices such as the management compensation plan or major corporate acquisitions. The right to maintain one’s proportional interest in the corporation through purchase of additional common stock if and when it is issued.

Common Stock Rex Corporation issued 5,000 shares of common stock with a par value of $1 on April 1, 2005, for $30,000 cash. Apr. 1 Cash 30,000 Common Stock 5,000 Additional Paid-In Capital 25,000 at Par Value

Preferred Stock The title “preferred” stock is somewhat misleading. Preferred isn’t better; it’s different.

The rights of ownership given up by preferred stockholders: Voting: In most cases, preferred stockholders are not allowed to vote for the board of directors. Sharing in success: The cash dividends received by preferred stockholders are usually fixed in amount. If the company does exceptionally well, preferred stockholders do not get to share in the success.

The protection enjoyed by preferred stockholders is: Cash dividend preference: Preferred stockholders are entitled to receive their full cash dividend before any cash dividend can be issued to common stockholders. Liquidation preference: If the company goes bankrupt, preferred stockholders are entitled to have their investment repaid in full, before common stockholders receive anything.

Preferred Stock Cumulative Has the right to receive accumulated dividends before any dividends may be paid to common stockholders. Non- Cumulative Has no right to “passed” dividends. Participating Has claim to a portion of common dividends after receiving preferred dividends.

Preferred Stock Convertible Callable Redeemable Permits the holder to exchange preferred stock for common stock. Callable Permits the issuing company to redeem the preferred stock. Redeemable Permits the holder to redeem the stock—usually with some restrictions.

Preferred Stock Dividends on cumulative preferred stock that are passed are referred to as dividends in arrears. And… dividends are not a liability until declared by the board of directors.

Preferred Stock Participating preferred stock issues provide for additional dividends to be paid to preferred stockholders after dividends of a specified amount are paid to common stockholders. Callable preferred stock is preferred stock that is redeemable at the option of the corporation. Redeemable preferred stock is preferred stock that is redeemable at the option of the stockholder.

Capital Stock Issued for Cash Goode Corporation issued 4,000 shares of $1 par common stock on April 1, 2005, for $45,000 cash. Apr. 1 Cash 45,000 Common Stock 4,000 Paid-In Capital in Excess of Par 41,000

Capital Stock Issued for Cash On April 1, 2005, Goode Corporation issued 4,000 shares of no-par common stock without a stated value for $45,000 cash. Apr. 1 Cash 45,000 Common Stock 45,000

Capital Stock Sold on Subscription On November 1, 2005, a firm received subscriptions for 5,000 shares of $1 par common at $12.50 per share with 50% down, balance due in 60 days. Nov. 1 Common Stock Subscription Receivable 62,500 Common Stock Subscribed 5,000 Paid-In Capital in Excess of Par 57,500

Capital Stock Sold on Subscription On November 1, 2005, a firm received subscriptions for 5,000 shares of $1 par common at $12.50 per share with 50% down, balance due in 60 days. Nov. 1 Cash 31,250 Common Stock Subscription Receivable 31,250

Capital Stock Sold on Subscription On December 9, received balance due on one-half of subscribers and issued stock to fully paid subscribers, 2,500 shares. Dec. 9 Cash 15,625 Common Stock Subscription Receivable 15,625 9 Common stock Subscribed 2,500 Common Stock 2,500

Stock Issued for Consideration Other Than Cash AC Company issues 200 shares of $0.50 par value common stock in return for land. The company’s stock is currently selling for $50 per share. Dec. 5 Land 10,000 Common Stock 100 Paid-In Capital in Excess of Par 9,900

Stock Issued for Consideration Other Than Cash Assume that the land has a readily determinable market price of $12,000, but AC Company’s common stock has no established fair market value. Dec. 5 Land 12,000 Common Stock 100 Paid-In Capital in Excess of Par 11,900

Companies acquired their own stock to… Stock Repurchases Companies acquired their own stock to… Provide shares for incentive compensation and employee savings plans. 2. Obtain shares needed to satisfy requests by holders of convertible securities. Reduce the amount of equity relative to the amount of debt. Invest excess cash temporarily. Remove some shares from the open market in order to protect against a hostile takeover. 6. Improve per-share earnings by reducing the number of shares outstanding and returning inefficiently used assets to shareholders. 7. Display confidence that the stock is currently undervalued by the market.

Treasury Stock Stock issued by a corporation but subsequently reacquired by and held in the name of the corporation and held for possible future reissuance or retirement. Reported as a contra-equity account, not as an asset. Does not create a gain or loss on reacquisition, reissuance, or retirement. May decrease Retained Earnings, but cannot increase it. There are two methods to account for treasury stock transactions: (1) Cost method and (2) Par value method

Issued 10,000, $1 par value shares at $15 per share Treasury Stock Issued 10,000, $1 par value shares at $15 per share Cost Method Cash 150,000 Common Stock. 10,000 Paid-In Capital in Excess of Par 140,000 Par Value Method Cash 150,000 Common Stock. 10,000 Paid-In Capital in Excess of Par 140,000

Reacquired 1,000 shares at $40 per share. Treasury Stock Reacquired 1,000 shares at $40 per share. Cost Method Treasury Stock 40,000 Cash 40,000 Par Value Method Treasury Stock 1,000 Paid-In Capital in Excess of Par 14,000 Retained Earnings 25,000 Cash 40,000 The balance

Sold 200 shares of treasury stock at $50 per share. Cost Method Cash 10,000 Treasury Stock 8,000 Paid-In Capital from Treasury Stock 2,000 Par Value Method Cash 10,000 Treasury Stock 200 Paid-In Capital in Excess of Par 9,800

Sold 500 shares of treasury stock at $34 per share. Cost Method Cash 17,000 Paid-In Capital from Treasury Stock 2,000 Retained Earnings 1,000 Treasury Stock 20,000 Par Value Method Cash 17,000 Treasury Stock 500 Paid-In Capital in Excess of Par 16,500

Retired remaining 300 shares of treasury stock. Cost Method Common Stock 300 Paid-In Capital in Excess of Par 4,200 Retained Earnings 7,500 Treasury Stock 12,000 Par Value Method Common Stock 300 Treasury Stock 300

Stock Rights, Warrants, and Options Stock rights—Issued to existing shareholders to permit them to maintain their proportionate ownership interests when new shares are to be issued. Stock warrants—Sold by the corporation for cash, generally in conjunction with the issuance of another security. Stock options—Granted to officers or employees, usually as part of a compensation plan.

Stock Warrants Stewart Co. sells 1,000 shares of $50 par preferred stock for $58 per share. Stewart Co. gives the purchaser detachable warrants enabling the holders to subscribe to 1,000 shares of $2 par common stock for $25 per share. Immediately following the issuance of the stock, the warrants are selling for $3, and the fair market value of a preferred share without the warrant attached is $57.

Stock Warrants = $3 $57 + $3 Value assigned to warrants Total issue price Market value of warrants x = Market value of security without warrants Market value of warrants + $57 + $3 Value assigned to warrants = $58,000 x $3 = $2,900

Stock Warrants The entry on Stewart’s book to record the sale of the preferred stock with detachable warrants is: Cash 58,000 Preferred Stock, $50 par 50,000 Paid-In Capital in Excess of Par--Preferred Stock 5,100 Common Stock Warrants 2,900

Stock Warrants If the warrants are exercised, the entry to record the issuance of common stock is: Common Stock Warrants 2,900 Cash 25,000 Common Stock, $2 par 2,000 Paid-In Capital in Excess of Par—Common Stock 25,900

Stock Warrants If these warrants were allowed to expired, what entry would be required? Common Stock Warrants 2,900 Paid-In Capital from Expired Warrants 2,900

Stock-Based Compensation On January 1, 2003, the board of directors of Neff Company authorize the grant of 10,000 stock options. Each option permits the purchase of one share of Neff common stock at $50 per share. The options vest or becomes exercisable on Jan 1, 2006.

Stock-Based Compensation The company estimates a grant date value of $10 for each of the employee stock options. The total fair value of the options granted is $100,000. Compensation cost is allocated over three years from January 1, 2003 (the grant date) to January 1, 2006 (the vesting date). On January 1, 2003, the board of directors of Neff Company authorize the grant of 10,000 stock options. Each option permits the purchase of one share of Neff common stock at $50 per share.

Stock-Based Compensation (Fair Value Method)* Dec. 31 Compensation Expense 33,333 Paid-In Capital from Stock Options 33,333 2003 $100,000 ÷ 3 Similar entries would be made in 2004 and 2005. * There is also the Intrinsic Value Method, in which case these entries would not be made.

* Under the intrinsic value method, the entry would have been: Stock-Based Compensation (Fair Value Method)* On December 31, 2006, all 10,000 of the options are exercised to purchase Neff’s no-par common stock. Dec. 31 Cash 500,000 Paid-In Capital from Stock Options 100,000 Common Stock (no par) 600,000 2006 * Under the intrinsic value method, the entry would have been: Dec. 31 Cash 500,000 Common Stock (no par) 500,000 2006

* The entry would have been the same under the Intrinsic Value Method. Stock-Based Compensation (Fair Value Method)* If the options had been allowed to expired, the following entry would have been necessary on December 31, 2006: Dec. 31 Paid-In Capital from Stock Options 100,000 Paid-In Capital from Expired Options 100,000 2006 * The entry would have been the same under the Intrinsic Value Method.

Stock Conversions Case 1 On December 31, 2005, 1,000 shares of preferred stock (par $50 and original selling price of $60) are exchanged for 4,000 shares of common stock (par $1) Dec. 31 Preferred Stock, $50 par 50,000 Paid-In Capital in Excess of Par—Preferred 10,000 Common Stock 4,000 Paid-In Capital in Excess of Par—Common 56,000 2005

Stock Conversions Case 2 On December 31, 2005, 1,000 shares of preferred stock (par $50 and original selling price of $60) are exchanged for 4,000 shares of common stock (par $20) Dec. 31 Preferred Stock, $50 par 50,000 Paid-In Capital in Excess of Par—Preferred 10,000 Retained Earnings 20,000 Common Stock 80,000 2005

Accounting for Dividends Declaration date: The date the corporation’s board of directors formally declares a dividend will be paid. Date of record: The date on which stockholders of record are identified as those who will receive a dividend. Date of payment: The date when the dividend is actually distributed to stockholders.

Cash Dividend ABC Corporation declares a $100,000 dividend; the following journal entries should be made: Declaration Date Dividends (or Retained Earnings) 100,000 Dividends Payable 100,000 Payment Date Dividends Payable 100,000 Cash 100,000

Property Dividend It is a distribution to stockholders that is payable in some asset other than cash.

Property Dividend Bigley Corporation owns 100,000 shares in Tri-State Oil Co, carrying value $2,700,000, current market value $3,000,000, or $30 per share. There are 1,000,000 shares of Bigley stock outstanding. A dividend of 1/10 of a share of Tri-State Oil Co. is declared for each share of Bigley stock outstanding.

Declaration of Dividend Property Dividend Declaration of Dividend Dividend (or Retained Earnings) 3,000,000 Property Dividends Payable 2,700,000 Gain on Distribution of Property Dividend 300,000 Payment of Dividend Property Dividends Payable 2,700,000 Investment in Tri-State Oil Co. 2,700,000

Stock Dividends Small Less than 20-25% of the outstanding shares. Debit Retained Earnings for the (post) MARKET value of the shares. Large Greater than 20-25% of the shares outstanding. Debit Retained Earnings for the PAR value of the shares.

Example 1: Stock Dividend Assume the following about Gean, Inc.: Common stock ($2 par, 10,000 shares outstanding) $20,000 Additional paid-in capital $24,200 Retained earnings $12,500 Stock dividend declared 1,500 shares Market price of stock $10/share Is this a large or small stock dividend?..Because 1,500 shares represent 15% of the outstanding stock, it is a small stock dividend.

Example 1: Stock Dividend Declaration Date Retained Earnings 15,000 Stock Dividends Distributable 3,000 Paid-In Capital in Excess of Par 12,000 Issuance Date Stock Dividends Distributable 3,000 Common Stock 3,000

Example 2: Stock Dividend Assume the following about Gimli’s Corp.: Common Stock ($5 par, 20,000 shares outstanding) $100,000 Additional Paid-In Capital $100,000 Retained Earnings $52,000 Stock Dividend Declared 10,000 shares Market Price of Stock $20/share 50% = large dividend Is this a large or small stock dividend?

Example 2: Stock Dividend Declaration Date Retained Earnings 50,000 Stock Dividends Distributable 50,000 Issuance Date Stock Dividends Distributable 50,000 Common Stock 50,000

Unrealized Gains and Losses on Available-For-Sale Securities Available-for-sale securities are those that were not purchased with the immediate intention to resell… …but the company also doesn’t necessarily plan to hold these securities forever.

The impact of other income-related equity items Kendell had net income of $1,350. Other items that impacted net income are: Unrealized gain (loss) on available- for-sale securities $100 (Increase) Decrease in minimum pension liability (60 ) Unrealized gain (loss) on derivative instruments (20 ) Foreign currency translation adjustment, increase (decrease) in stockholders’ equity 300

Unrealized Gains and Losses on Available-For-Sale Securities Net income $1,350 Other comprehensive income: Unrealized gain on available-for- sale securities 60 Increase in minimum pension liability (36 ) Unrealized loss on derivative instruments (12 ) Foreign current transaction adjustments 180 Comprehensive income $1,542

Liquidating Dividend A liquidating dividend is a distribution representing a return to stockholders of a portion of contributed capital. See page 672 of text.

Disclosures Related to the Equity Section Capital stock may be: Authorized but unissued. Subscribed for and held for issuance pending receipt of cash for the full amount of the subscription price. Outstanding in the hands of stockholders. Reacquired and held by the corporation for subsequent reissuance. Canceled by appropriate corporate action.