© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Chapter 19 Shareholders’ Equity

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 19-2 The Nature of Shareholders’ Equity Assets – Liabilities = Shareholders’ Equity Net Assets (Residual Interest)

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 19-3 Sources of Shareholders’ Equity Stockholders’ Equity Paid-in Capital Retained Earnings Amounts earned by corporation Amounts invested by shareholders

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 19-4 The Corporate Organization Advantages: Limited liability. Ease of raising capital. Ease of ownership transfer. Lack of mutual agency. Disadvantages: Double taxation. Government regulation. Advantages: Limited liability. Ease of raising capital. Ease of ownership transfer. Lack of mutual agency. Disadvantages: Double taxation. Government regulation.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 19-5 Types of Corporations Not-for-profit corporations include hospitals, charities, and government agencies such as FDIC. Privately-held corporations whose shares are owned by only a few individuals. Publicly-held corporations whose shares are widely owned by the general public.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 19-6 Hybrid Organizations S Corporation Limited liability protection of a corporation. Maximum number of owners. Limited liability company Limited liability protection of a corporation. All owners may be involved in management without losing limited liability protection. No limit on number of owners. Limited liability partnership Owners are liable for their own actions but not entirely liable for actions of other partners. S Corporation Limited liability protection of a corporation. Maximum number of owners. Limited liability company Limited liability protection of a corporation. All owners may be involved in management without losing limited liability protection. No limit on number of owners. Limited liability partnership Owners are liable for their own actions but not entirely liable for actions of other partners. Double taxation avoided.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 19-7 Formation of a Corporation Number and classes of shares authorized. Composition of initial board of directors. Nature and location of business activities. Corporate Charter

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 19-8 Formation of a Corporation Articles of incorporation are filed with the state. Board of directors elected by shareholders. Board of directors appoint officers. Shares of stock issued. State issues a corporate charter.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 19-9 Fundamental Share Rights Right to vote. Right to share in distribution of assets if company is liquidated. Right to share in profits when dividends are declared. Preemptive right to maintain percentage ownership.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Classification of capital stock Authorized Issued Unissued Treasury stock Outstanding Subscribed Concepts and Definitions

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Authorized, Issued, and Outstanding Capital Stock Authorized Shares The maximum number of shares of capital stock that can be sold to the public is called the authorized number of shares.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Authorized, Issued, and Outstanding Capital Stock Issued shares are authorized shares of stock that have been sold. Unissued shares are authorized shares of stock that have never been sold. Authorized Shares

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Authorized, Issued, and Outstanding Capital Stock Unissued Shares Treasury Shares Outstanding Shares Treasury shares are issued shares that have been reacquired by the corporation. Issued Shares Outstanding shares are issued shares that are owned by stockholders. Authorized Shares

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Capital Stock Par value stock Designated dollar amount per share stated in the corporate charter. Par value has no relationship to market value. No-par stock Dollar amount per share not designated in corporate charter. Corporations can assign a stated value per share (treated as if par value).

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Legal capital is... The portion of stockholders’ equity that must be contributed to the firm when stock is issued. The amount of capital, required by state law, that must remain invested in the business. Refers to par value, stated value, or full amount paid for no-par stock. Legal capital is... The portion of stockholders’ equity that must be contributed to the firm when stock is issued. The amount of capital, required by state law, that must remain invested in the business. Refers to par value, stated value, or full amount paid for no-par stock. Capital Stock

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Types of Capital Stock CommonPreferred

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide The basic voting stock of the corporation. Ranks after preferred stock for dividend and liquidation distribution. Dividends determined by the board of directors. The basic voting stock of the corporation. Ranks after preferred stock for dividend and liquidation distribution. Dividends determined by the board of directors. Common Stock

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Preferred Stock Dividend and liquidation preference over common stock. Generally does not have voting rights. Usually has a par or stated value. May be convertible, callable, and/or redeemable.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Are usually stated as a percentage of the par or stated value. May be cumulative or noncumulative. May be partially participating, fully participating, or nonparticipating. Are usually stated as a percentage of the par or stated value. May be cumulative or noncumulative. May be partially participating, fully participating, or nonparticipating. Preferred Stock Dividends

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Preferred Stock Dividends Cumulative Unpaid dividends must be paid in full before any distributions to common stock. Dividends in arrears are not liabilities, but the per share and aggregate amounts must be disclosed.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Issuing Stock for Cash 10,000 shares of $1 par value stock is issued for $100,000 cash.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Issuing Stock for Cash 10,000 shares of no-par stock is issued for $100,000 cash.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Issuing Stock for Cash 10,000 shares of no-par stock, with a stated value of $1 is issued for $100,000 cash.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Issuing Stock for Noncash Assets Apply the general valuation principle by using fair value of stock given up or fair value of asset received, whichever is more clearly evident. If market values cannot be determined, use appraised values. Apply the general valuation principle by using fair value of stock given up or fair value of asset received, whichever is more clearly evident. If market values cannot be determined, use appraised values.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide More Than One Security Issued for a Single Price Allocate the lump-sum received based on the relative fair values of the two securities. If only one fair value is known, allocate a portion of the lump-sum received based on that fair value and allocate the remainder to the other security. Allocate the lump-sum received based on the relative fair values of the two securities. If only one fair value is known, allocate a portion of the lump-sum received based on that fair value and allocate the remainder to the other security.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Toys, Inc. issued 5,000 shares of common stock, $10 par value and 3,000 shares of preferred stock, $5 par value for $450,000. The market values of the common stock and preferred stock were $55 and $75, respectively. Calculate the paid-in capital in excess of par for each class of stock. Toys, Inc. issued 5,000 shares of common stock, $10 par value and 3,000 shares of preferred stock, $5 par value for $450,000. The market values of the common stock and preferred stock were $55 and $75, respectively. Calculate the paid-in capital in excess of par for each class of stock. More Than One Security Issued for a Single Price

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Record the journal entry for issuing the stock. More Than One Security Issued for a Single Price

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide More Than One Security Issued for a Single Price

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Share Issue Costs Share issue costs reduce net proceeds from selling shares, resulting in a lower amount of Paid-in Capital in Excess of Par. Registration fees Underwriter commissions Printing and clerical costs Legal and accounting fees Promotional costs

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Let’s turn our attention to reacquiring shares.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Share Buybacks A corporation might reacquire shares of its stock to... Support the market price. Increase earnings per share. Distribute in stock option plans. Issue as a stock dividend. Use in mergers and acquisitions. Thwart takeover attempts. A corporation might reacquire shares of its stock to... Support the market price. Increase earnings per share. Distribute in stock option plans. Issue as a stock dividend. Use in mergers and acquisitions. Thwart takeover attempts.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide I can account for the reacquired shares by retiring them or by holding them as treasury shares. Share Buybacks

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Accounting for Retired Shares When shares are formally retired, we reduce the same capital accounts that were increased when the shares were issued – Common or Preferred Stock, and Paid-in Capital in Excess of Par.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide ,000 shares of $2 par value stock that were issued for $20 per share are reacquired for $17 per share.  Price paid is less than issue price. Accounting for Retired Shares

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide  Price paid is more than issue price. 5,000 shares of $2 par value stock that were issued for $20 per share are reacquired for $25 per share. Accounting for Retired Shares Reduce Retained Earnings if the Paid-in Capital – Share Repurchase account balance is insufficient.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Treasury Stock Usually does not have: Voting rights. Dividend rights. Preemptive rights. Liquidation rights. Reduces both assets and stockholders’ equity.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Accounting for Treasury Stock (one-transaction concept) (rarely used, not covered in this chapter)

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Acquisition of Treasury Stock Recorded at cost to acquire. Resale of Treasury Stock Treasury Stock credited for cost. Difference between cost and issuance price is (generally) recorded in Paid-in Capital – Share Repurchase. Acquisition of Treasury Stock Recorded at cost to acquire. Resale of Treasury Stock Treasury Stock credited for cost. Difference between cost and issuance price is (generally) recorded in Paid-in Capital – Share Repurchase. Accounting for Treasury Stock

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide On 5/1/03, Photos-in-a-Second reacquired 3,000 shares of its common stock at $55 per share. On 12/3/04, Photos-in-a-Second reissued 1,000 shares of the stock at $75 per share. Which of the following would be included in the 12/3 entry? a. Credit Cash for $165,000. b. Debit Treasury Stock for $75,000. c. Credit Treasury Stock for $55,000. d. Credit Cash for $75,000. On 5/1/03, Photos-in-a-Second reacquired 3,000 shares of its common stock at $55 per share. On 12/3/04, Photos-in-a-Second reissued 1,000 shares of the stock at $75 per share. Which of the following would be included in the 12/3 entry? a. Credit Cash for $165,000. b. Debit Treasury Stock for $75,000. c. Credit Treasury Stock for $55,000. d. Credit Cash for $75,000. Accounting for Treasury Stock

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide On 5/1/03, Photos-in-a-Second reacquired 3,000 shares of its common stock at $55 per share. On 12/3/04, Photos-in-a-Second reissued 1,000 shares of the stock at $75 per share. Which of the following would be included in the 12/3 entry? a. Credit Cash for $165,000. b. Debit Treasury Stock for $75,000. c. Credit Treasury Stock for $55,000. d. Credit Cash for $75,000. On 5/1/03, Photos-in-a-Second reacquired 3,000 shares of its common stock at $55 per share. On 12/3/04, Photos-in-a-Second reissued 1,000 shares of the stock at $75 per share. Which of the following would be included in the 12/3 entry? a. Credit Cash for $165,000. b. Debit Treasury Stock for $75,000. c. Credit Treasury Stock for $55,000. d. Credit Cash for $75,000. Solution Accounting for Treasury Stock

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Accounting for Treasury Stock

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Reporting Treasury Stock Reported in Shareholders’ Equity. Unallocated reduction of total Shareholders’ Equity. Reported in Shareholders’ Equity. Unallocated reduction of total Shareholders’ Equity.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Retained Earnings Represents the undistributed earnings of the company since its inception.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Retained Earnings The statement of retained earnings may also contain the correction of an accounting error that occurred in the financial statements of a prior period, called a prior period adjustment. Any restrictions on retained earnings must be disclosed in the notes to the financial statements. The statement of retained earnings may also contain the correction of an accounting error that occurred in the financial statements of a prior period, called a prior period adjustment. Any restrictions on retained earnings must be disclosed in the notes to the financial statements.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Let’s change the subject to dividends.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Cash Dividends Dividends must be declared by the board of directors before they can be paid. When a dividend is declared, a liability is created. A corporation is not legally required to pay dividends. Cash dividends require sufficient cash and retained earnings to cover the dividend.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Dividend Dates Declaration date Board of directors declares the dividend. Record a liability.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Dividend Dates Ex-dividend date The latest date for stock purchase that entitles the stockholder to receive the declared dividend. (No entry) July X

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Dividend Dates Date of record Stockholders holding shares on this date will receive the dividend. (No entry) X July

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Dividend Dates Date of payment Record the payment of the dividend to stockholders.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Property Dividends Distributions of non- cash assets. Record at fair value of non-cash asset. Recognize gain or loss for difference between book value and fair value.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Stock Dividends All stockholders receive the same percentage increase in shares. No change in total stockholders’ equity. No change in par values. Distribution of additional shares of stock to stockholders.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Stock Dividends Reasons for stock dividends: To preserve cash. To decrease market price of stock. To reduce existing balance in Retained Earnings.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Record at current market value of stock. Stock dividend < 25% Stock Dividends Stock dividend 25% Record at par or stated value of stock. SmallLarge >

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Stock Dividends CarCo declares and distributes a 20% stock dividend on 5 million common shares. Par value is $1 and market value is $20. Prepare the required journal entry.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Stock Dividends CarCo declares and distributes a 20% stock dividend on 5 million common shares. Par value is $1 and market value is $20. Prepare the required journal entry.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Stock Splits Decrease par value of stock. Increase number of outstanding shares. No change in total stockholders’ equity. Does not require a journal entry. Ice Cream Parlor Banana Splits On Sale Now

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Accounting for Stock Splits A corporation had 5,000 shares of $1 par value common stock outstanding before a 2–for–1 stock split.

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Accounting for Stock Splits A corporation had 5,000 shares of $1 par value common stock outstanding before a 2–for–1 stock split. Increase Decrease No Change

© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Chester, would you like to buy some stock in my internet.com company? End of Chapter 19