SHAREHOLDERS’ EQUITY Chapter 18 © 2009 The McGraw-Hill Companies, Inc.

McGraw-Hill /Irwin Slide 2 The Nature of Shareholders’ Equity Assets – Liabilities = Shareholders’ Equity Shareholders’ Equity Paid-in Capital Retained Earnings Amounts earned by corporation Amounts invested by shareholders Accumulated Other Comprehensive Income Other gains and losses not included in net income Sources of Shareholders’ Equity Net Assets

McGraw-Hill /Irwin Slide 3 The Corporate Organization Continuous Existence Easy ownership transfer Limited liability Easy to raise capital Disadvantages of a corporation Advantages of a corporation Double taxation Government regulation

McGraw-Hill /Irwin Slide 4 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.

McGraw-Hill /Irwin Slide 5 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.

McGraw-Hill /Irwin Slide 6 Board of directors appoint officers. The Model Business Corporation Act Articles of incorporation are filed with the state. Board of directors elected by shareholders. Shares of stock issued. State issues a corporate charter. Corporate Charter Nature and location of business activities. Number and classes of shares authorized.

McGraw-Hill /Irwin Slide 7 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.

McGraw-Hill /Irwin Slide 8 Issued shares are authorized shares of stock that have been sold. Unissued shares are authorized shares of stock that never have been sold. Authorized shares are the maximum number of shares of capital stock that can be sold to the public. Authorized, Issued, and Outstanding Shares

McGraw-Hill /Irwin Slide 9 Authorized Shares Unissued Shares Treasury Shares Outstanding Shares Issued Shares Treasury shares are issued shares that have been reacquired by the corporation. Outstanding shares are issued shares that are owned by stockholders. Authorized, Issued, and Outstanding Shares Retired Shares Retired shares have the same status as authorized but unissued shares.

McGraw-Hill /Irwin Slide 10 Capital Stock Par value stock Dollar amount per share is stated in the corporate charter. Par value has no relationship to market value. No-par stock Dollar amount per share is not designated in corporate charter. Corporations can assign a stated value per share (treated as if par value). Legal capital is...  The portion of shareholders’ 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.

McGraw-Hill /Irwin Slide 11 Capital Stock Common stock is the basic voting stock of the corporation. It ranks after preferred stock for dividend and liquidation distribution. Dividends are determined by the board of directors. 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. Preferred Stock

McGraw-Hill /Irwin Slide 12 Preferred Stock Dividends 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. 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.

McGraw-Hill /Irwin Slide 13 Comprehensive Income Deferred gains (losses) from derivatives. Gains (losses) from and amendments to post retirement benefit plans. Gains (losses) from foreign currency translations. Comprehensive income includes four types of gains and losses that traditionally have been excluded from net income. Net holding gains (losses) on investments.

McGraw-Hill /Irwin Slide 14 Comprehensive income is reported periodically as it is created and also is reported as a cumulative amount. Comprehensive Income There are 3 options for reporting comprehensive income created during the reporting period. The accumulated amount of comprehensive income is reported as a separate item of shareholders’ equity in the balance sheet. As a separate statement. As an additional section of the income statement. As part of the statement of shareholders’ equity.

McGraw-Hill /Irwin Slide 15 Shares Issued for Cash 10,000 shares of stock are issued for $100,000 cash. $1 Par Value No Par Value No Par, $1 Stated Value

McGraw-Hill /Irwin Slide 16 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.

McGraw-Hill /Irwin Slide 17 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. 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 additional paid-in capital for each class of stock.

McGraw-Hill /Irwin Slide 18 More Than One Security Issued for a Single Price

McGraw-Hill /Irwin Slide 19 Share Issue Costs Share issue costs reduce net proceeds from selling shares, resulting in a lower amount of additional paid-in capital. Registration fees Underwriter commissions Printing and clerical costs Legal and accounting fees Promotional costs

McGraw-Hill /Irwin Slide 20 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. I can account for the reacquired shares by retiring them or by holding them as treasury shares.

McGraw-Hill /Irwin Slide 21 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 additional paid-in capital. 5,000 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.

McGraw-Hill /Irwin Slide 22  Price paid is more than issue price. Accounting for Retired Shares Reduce Retained Earnings if the Paid-in Capital – Share Repurchase account balance is insufficient. 5,000 shares of $2 par value stock that were issued for $20 per share are reacquired for $25 per share.

McGraw-Hill /Irwin Slide 23 Accounting for Treasury Stock 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. Treasury stock usually does not have: Voting rights. Dividend rights. Preemptive rights. Liquidation rights. Treasury stock is reported as an unallocated reduction of total Shareholders’ Equity.

McGraw-Hill /Irwin Slide 24 On 5/1/08, Photos-in-a-Second reacquired 3,000 shares of its common stock at $55 per share. On 12/3/09, Photos-in-a- Second reissued 1,000 shares of the stock at $75 per share. Which of the following would be included in the 12/3/09 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

McGraw-Hill /Irwin Slide 25 Retained Earnings Represents the undistributed earnings of the company since its inception. 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.

McGraw-Hill /Irwin Slide 26 Example: Shareholders’ Equity Section of a Balance Sheet

McGraw-Hill /Irwin Slide 27 Accounting for Cash Dividends Accounting for Cash Dividends Declared by board of directors. Not legally required. Creates liability at declaration. Requires sufficient Retained Earnings and Cash. Declaration date Board of directors declares the dividend. Record a liability.

McGraw-Hill /Irwin Slide 28 Date of Record Stockholders holding shares on this date will receive the dividend. (No entry) Dividend Dates Dividend Dates Date of Payment Record the dividend payment to stockholders. Ex-dividend date The first day the shares trade without the right to receive the declared dividend. (No entry)

McGraw-Hill /Irwin Slide 29 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. 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.

McGraw-Hill /Irwin Slide 30 Accounting for Stock Dividends Accounting for Stock Dividends Distribution of additional shares of stock to owners. No change in total stockholders’ equity. All stockholders retain same percentage ownership. No change in par values. Stock dividend < 25% Record at current fair value of stock. Small Stock dividend > 25% Record at par value of stock. Large

McGraw-Hill /Irwin Slide 31 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. Accounting for Stock Dividends Accounting for Stock Dividends

McGraw-Hill /Irwin Slide 32 Stock splits change the par value per share and the number of shares outstanding, but the total par value is unchanged, and no journal entry is required. Stock Splits Stock Splits Assume that a corporation had 3,000shares of $2 par value common stock outstanding before a 2–for–1 stock split. Increase Decrease No Change

McGraw-Hill /Irwin Slide 33 Stock Splits Effected in the Form of Large Stock Dividends Matrix, Inc. declares and distributes a 2-for-1 stock split effected in the form of a 100% stock dividend. The company has 1,000,000, $1 par value common stock outstanding. The stock is trading in the open market for $14 per share. The per share par value of the shares is not to be changed.

McGraw-Hill /Irwin Slide 34 Appendix 18 ─ Quasi Reorganizations Purpose To allow a company undergoing financial difficulty, but with favorable future prospects, to get a fresh start by writing down inflated assets and eliminating an accumulated balance in retained earnings. Procedures Assets and liabilities are revalued to reflect market values, with corresponding debits and credits to retained earnings. The debit balance in retained earnings is eliminated first against additional paid in capital, and then, if necessary, against common stock. Retained earnings is dated to indicate when the new accumulation of earnings began.

McGraw-Hill /Irwin Slide 35 Emerson-Walsch Corporation has incurred losses for several years. The board of directors voted to implement a quasi reorganization, subject to shareholder approval. The balance sheet prior to restatement, in millions, follows : Quasi Reorganizations Fair values: Inventory = $300,000,000 and Property, plant, and equipment = $225,000,000. Let’s prepare the journal entries necessary for the quasi reorganization.

McGraw-Hill /Irwin Slide 36 To revalue assets Quasi Reorganizations To eliminate the deficit in retained earnings $300 + $250

McGraw-Hill /Irwin Slide 37 Balance sheet immediately after restatement. Quasi Reorganizations

McGraw-Hill /Irwin End of Chapter 18 © 2008 The McGraw-Hill Companies, Inc.