1 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Stockholders’ Equity Chapter 10 2 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Explain the features of a corporation 3 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Corporate Characteristics ADVANTAGES DISADVANTAGES Separate legal entity Continuous life Transferability of ownership Limited liability Separation of ownership and management Corporate taxation Government regulation 4 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Organizing a Corporation Corporate organizers (incorporators) obtain a charter from the state ▫Charter includes authorization to issue shares of stock Incorporators: ▫Pay fees ▫Sign the charter ▫File documents with the state ▫Agree to set of bylaws 5 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

6 Stockholders Chairperson of the Board Board of Directors President (Chief Operating Officer) Vice- Presidents Chief Financial Officer Secretary Controller Treasurer

Stockholder Rights VoteDividends LiquidationPreemption 7 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Stockholders’ Equity ? Amount stockholders have contributed ? Amount earned by profitable operations 8 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Classes of Stock COMMON PREFERRED Basic form of stock Has four basic rights Shareholders benefit most if corporation succeeds ▫Take more risk Has advantages over common ▫Receive dividends first ▫Receive assets first in liquidation Shareholders earn a fixed dividend Very few corporations issue 9 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Comparison of Issuing Stock and Debt Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 10 Common stock Preferred stock Long-term debt Obligation to repay principal No Yes Dividends/interestDividends are not tax deductible Interest expense is tax deductible Obligation to pay dividends/interest Only after declaration At fixed rates and date

Par Value Arbitrary amount assigned to share of stock Usually set low to avoid legal issues ▫Most states do not allow companies to issue stock below par No-par stock ▫May have a stated value 11 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Account for the issuance of stock 12 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Issuing Stock at Par Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 13 JOURNAL DateAccounts and explanationDebitCredit Cash50,000 Common stock50,000 Issued stock at par value

Issuing Stock above Par Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 14 JOURNAL DateAccounts and explanationDebitCredit Cash300,000 Common stock50,000 Paid-in capital in excess of par - Common250,000 Issued stock above par value

Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 15 A company neither earns a profit nor incurs a loss when it sells it stock to, or buys stock from, its own shareholders.

Issuing No-Par Stock Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 16 JOURNAL DateAccounts and explanationDebitCredit Cash300,000 Common stock300,000 Issued no-par stock

Stock Issued for Non-Cash Assets Asset received is recorded at current market value 17 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. JOURNAL DateAccounts and explanationDebitCredit Equipment100,000 Common stock20,000 Paid-in capital in excess of par - Common80,000 Issued stock in exchange for equipment

Stock Issued for Services Expense recognized for fair value of services rendered 18 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. JOURNAL DateAccounts and explanationDebitCredit Legal expense25,000 Common stock2,500 Paid-in capital in excess of par - Common22,500 Issued stock in exchange for legal services

Preferred Stock Follows same pattern as accounting for common stock May have separate accounts for paid-in capital in excess of par for preferred and common Can be issued with conversion feature ▫Allows preferred shareholders to exchange preferred shares for common 19 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Number of Shares AuthorizedIssued Outstanding 20 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Show how treasury stock affects a company 21 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Treasury Stock Issued shares reacquired by the company Reasons: ▫Make shares available for employee stock purchase plans ▫Plan to “buy low” and “sell high” ▫Avoid takeover ▫Increase earnings per share ▫Use in share repurchase program 22 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Recording Treasury Stock Recorded at cost ▫Not par value Classified as a contra-stockholders’ equity account ▫Debit balance 23 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. JOURNAL DateAccounts and explanationDebitCredit Treasury stock95,000 Cash95,000 Purchased treasury shares

Retiring Stock Cancel stock certificates Cannot be reissued 24 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. JOURNAL DateAccounts and explanationDebitCredit Common stock Additional paid-in capital Retained earnings Treasury stock

Resale of Treasury Shares Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 25 JOURNAL Date Accounts and explanationDebitCredit Cash100,000 Treasury stock95,000 Paid-in capital from treasury stock transactions 5,000 Purchased treasury shares

Exercise 10-24A Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 26 JOURNAL DateAccounts and explanationDebitCredit

Exercise 10-24A Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 27 Effect on Stockholders’ Equity 1-21Common stock issued 6-23Purchase of treasury stock 7-15Sale of treasury stock Total change

Account for retained earnings, dividends and splits 28 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Retained Earnings Cumulative Net income Net losses Dividends declared 29 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Retained Earnings Balance Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 30 Credit balance Lifetime earnings Lifetime losses & dividends > Debit balance Lifetime earnings Lifetime losses & dividends <

Cash Dividends Company must have both: ▫Enough Retained earnings to declare the dividend ▫Enough Cash to pay the dividend Board of directors has authority to declare a dividend ▫Company not obligated to pay dividend until declared 31 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Dividend Dates 32 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. JOURNAL Date Accounts and explanationDebitCredit 1. Declaration date 2. Date of record 3. Payment date JOURNAL Date Accounts and explanationDebitCredit No entry

Analyzing Retained Earnings Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 33 Retained Earnings Beginning balance Ending balance Net Income Dividends

Dividends on Preferred Stock Paid dividends before common stockholders Stated as a percent of par value or a dollar amount per share May be cumulative ▫Passed dividends are owed to preferred shareholders  In arrears ▫Almost debt 34 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Exercise 10-28A 35 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. Preferred dividend = $1.00 x 6% x 90,000 shares PreferredCommon $90,000 Dividends in arrears Current year Remainder to common $270,000 Preferred – current year Remainder to common

Stock Dividends Proportional distribution of stock to shareholders Increase stock account and decrease Retained earnings ▫Total equity is unchanged Reasons stock dividends are distributed ▫Continue dividends, but conserve cash ▫Reduce market price of shares 36 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Size of Stock Dividends SMALL LARGE 25% or less of outstanding shares Recorded at market value Greater than 25% of outstanding shares Recorded at par value 37 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Stock Splits Increase in shares with a proportionate reduction in par value Decreases market price of shares No accounts affected 38 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

39 Effect on Total: TransactionAssets=Liabilities + Stockholders’ Equity Issuance of stock Purchase of treasury stock Sale of treasury stock Declaration of cash dividend Payment of cash dividend Stock dividend Stock split

Use stock values in decision making 40 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Stock Values Market value Redemption value Liquidation value Book value 41 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

DuPont Analysis Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 42 Return on assets Net profit margin Asset turnover Leverage ratio Return on equity Leverage ratio Return on equity Net income Net sales Average total assets Average common equity Net income Average common equity

Report equity transactions in the financial statements 43 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

Equity Transactions on the Cash Flow Statement Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 44 TransactionShown in the Financing Activity Section as a: Issue stock for cash Purchase treasury stock Sell treasury stock Pay dividends

Stockholders’ Equity on the Balance Sheet Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 45 Stockholders’ Equity Preferred stock, 7%, $100 par, 5,000 shares authorized and issued$500,000 Common stock, $1 par, 100,000 shares authorized, 75,000 shares issued75,000 Additional paid-in capital2,500,000 Retained earnings1,300,000 Less treasury stock, common(50,000) Total stockholders’ equity $4,325,000

46 Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

47