1 Chapter 12 Contributed Capital Certificate of Stock Adapted from Financial Accounting 4e by Porter and Norton

2 Disadvantages Advantages Equity Financing: Issue Stock l Dividend flexibility l Ready markets l Often provides higher ROI than debt financing l Borrowing may not be feasible

3 Equity Financing: Issue Stock l Less control l Dividends not tax deductible l Hurts some financial ratios Disadvantages Advantages

4 Expanded Accounting Equation Assets = Liabilities + Owners’ Equity Assets = Liabilities + Stockholders’ Equity Contributed Capital Retained Earnings

5 Relationships among Financial Statements – Winnebago Industries, Inc. Statement of Change in Stockholders’ Equity for 2001 Beginning balance, reinvested income$ 195,556 Add: Net income42,704 Deduct: Cash dividends ( 4,121) Ending balance, reinvested income$ 234,139 Balance Sheet as of August 25, 2001 Total Assets$xxx Total Liabilitiesxxx Capital Stockxxx Reinvested Earnings 234,139 Total Liabilities & Stockholders' Equity$ xxx Income Statement for 2001 Revenues$ xxx Less: expenses xxx Net income$ 42,704

6 Stockholders’ Equity Components Preferred Stock Common Stock Addt’l. Paid-In Cap. Retained Earnings Donated Capital Other Misc. Deduct: Treasury Stock

7 Shareholders' equity: Preferred stock, 20 million shares authorized; none issued Common stock, $1 par value, 750 million shares authorized; 182,278,766 shares issued Additional paid-in capital 2,865 2,911 Treasury shares at cost: 2001 – 27,794,380; 2000 – 30,216,218 (1,716)(1,865) Accumulated other comprehensive loss (146) (2) Retained earnings 4,188 5,950 Total shareholders' equity 5,373 7,176 AMR Corporation’s Partial Balance Sheet (in millions)

8 Contributed Capital l Common Stock »basic stock of corporation »has voting rights »represents ownership interest l Preferred Stock »optional »tailored to meet specific needs »provides dividend returns with less risk Certificate of Stock

9 Outstanding - not repurchased or retired Issued - sold & distributed Number of Shares of Stock Authorized 1,000 Maximum Allowable

10 Par Value l “Legal capital” l Arbitrary amount stated on stock certificate l also called “stated value” Certificate of Stock $1.00 Par Value

11 Additional Paid-in Capital l Amount received in excess of par or stated value of stock Certificate of Stock $1.00 Par Value 15

12 Retained Earnings l Net income retained in business (not paid out as dividends) since inception l Reinvested in a variety of assets (not necessarily liquid)

13 Preferred Stock l Can tailor to specific needs of firm l Stated dividend rate l Often carries dividend preference over common stock $100 par, 7% Preferred Stock

14 Preferred Stock Features l Callable l Convertible Preferred Common l Cumulative l Participating

15 Stock Issued for Cash Journal Entry: Cash 15,000 Common Stock 10,000 Additional Paid-In Capital – Common 5,000 1,000 shares of $10 par value stock sold for $15 per share Common Stock $ 10,000 ( $10 par value x 1,000 shares) Addt’l Paid-In Cap. $5,000 (($15 - $10) x 1,000 shares) Example:

16 Stock Issued for Noncash Consideration l Record at fair market value of consideration given or received, whichever is more readily determinable Certificate of Stock Title to land, building, etc.

17 Treasury Stock l Company buys back its own stock l Contra-equity account (debit balance) l Not outstanding (no voting rights) Certificate of Stock

18 Reasons for Repurchasing Stock l Provide for bonus or benefit plans l Maintain favorable market value l Improve financial ratios l Maintain control of ownership l Cash in on future price increases

19 Presentation of Treasury Stock Common stock, $10 par, 1,000 shares issued, 900 outstanding $ 10,000 Additional paid-in capital 12,000 Retained earnings 15,000 37,000 Less: Treasury stock, 100 shares at cost ($25 per share) ( 2,500) Total stockholders’ equity$34,500

20 Cash Dividends Paid to Stockholders on date of record Date of declaration Payment date on dividend check for Date Dept.. of Treasurer Jane Doe

21 Dividends Record dividends when declared; not when paid Reduce retained earnings 12/31/031/15/04 Pay dividends

22 Recording Cash Dividends Retained EarningsXXX Cash Dividend Payable XXX To record the declaration of a cash dividend. Cash Dividend Payable XXX CashXXX To record dividend payment. dividend check for Date Dept.. of Treasurer Jane Doe

23 Dividend Requirements l Sufficient cash l Positive retained earnings

24 Dividend Payout Ratio Annual dividend Net income The % of earnings paid as dividends Dividend check for Date Dept.. of Treasurer Jane Doe I.M. Treasurer

25 Allocation of Cash Dividends 1) Distribute dividends in arrears, if any, to preferred 2) Distribute current dividends to preferred 3) Distribute remainder to common (or to both if preferred is participating)

26 Cash Dividends Example Stricker Company declares a $70,000 dividend for 2004 (no dividends were paid in 2002 or 2003). There are 10,000 shares of $10 par, 8% preferred stock and 40,000 shares of $5 par common stock outstanding.

27 Cash Dividends Example Preferred Common Step 1: Distribute current-year dividend to preferred (10,000 shares x $10 par x 8% x 1 yr.) $8,000 Step 2: Distribute remaining dividend to common ($70,000 - $8,000) $62,000 Total allocated $8,000 $62,000 Noncumulative Preferred Stock $0.80 per share $1.55 per share

28 Cash Dividends Example Preferred Common Step 1: Distribute dividends in arrears to preferred (10,000 shares x $10 par x 8% x 2 yrs.)$16,000 Step 2: Distribute current-year dividend to preferred (10,000 shares x $10 par x 8% x 1 yr.) 8,000 Step 3: Distribute remaining dividend to common ($70,000 - $24,000) $46,000 Total allocated$24,000 $46,000 Cumulative Preferred Stock $2.40 per share $1.15 per share

29 Cash Dividends Example Preferred Common Step 1: Distribute dividend in arrears to preferred (10,000 shares x $10 x 8% x 2 yrs.)$16,000 Step 2: Distribute current-year dividend to preferred (10,000 shares x $10 par x 8% x 1 yr.) 8,000 Step 3: Distribute equal percentage to common (40,000 shares x $5 x 8%) $16,000 Step 4: Remainder to preferred and common on basis of total par value 10,000 20,000 Total allocated$34,000 $36,000 Cumulative and Participating Preferred Stock $3.40 per share $0.90 per share

30 Stock Dividends l Reasons: l insufficient cash l market price reduction l nontaxable to recipients Certificate of Stock l Issue of additional shares proportionately to existing stockholders

31 Stockholders’ Equity: Common stock, $10 par, 5,000 shares $ 50,000 Additional paid-in cap. 30,000 Retained earnings 70,000 Total $150,000 Assume Shah Company declares 10% stock dividend; 500 $40 per share market value Before Dividend Small Stock Dividend Example

32 Stockholders’ Equity: Common stock, $10 par, 5,500 shares$ 50,000$ 55,000 Additional paid-in cap. 30,000 45,000 Retained earnings 70,000 50,000 Total$ 150,000$150,000 $40 market value deducted from retained earnings; allocated between Common Stock (initially Common Stock Dividend Distributable) and Additional Paid-In Capital. BeforeAfter Small Stock Dividend Example + + -

33 BeforeAfter Total S/E is unchanged Small Stock Dividend Example Stockholders’ Equity: Common stock, $10 par, 5,500 shares$ 50,000$ 55,000 Additional paid-in cap. 30,000 45,000 Retained earnings 70,000 50,000 Total$ 150,000$150,000

34 Stockholders’ Equity: Common stock, $10 par, 5,000 shares $ 50,000 Additional paid-in cap. 30,000 Retained earnings 70,000 Total $150,000 Assume Shah Company declares 100% stock dividend Before Dividend Large Stock Dividend Example

35 Stockholders’ Equity: Common stock, $10 par, 10,000 shares$ 50,000$100,000 Additional paid-in cap. 30,000 30,000 Retained earnings 70,000 20,000 Total$ 150,000$150,000 Dividend deducted from retained earnings and recorded in the Common Stock account at par. Additional Paid-In Capital account is unaffected. BeforeAfter Large Stock Dividend Example + -

36 Stockholders’ Equity: Common stock, $10 par, 10,000 shares$ 50,000$100,000 Additional paid-in cap. 30,000 30,000 Retained earnings 70,000 20,000 Total$ 150,000$150,000 BeforeAfter Total S/E is unchanged Large Stock Dividend Example + -

37 Stock Splits l Results in additional issuance of shares l Reduces par value per share l No change in Stockholders’ Equity accounts Certificate of Stock $3 par value Certificate of Stock $1 par value

38 Stock Splits l Not recorded in accounts l Splits reduce market value per share and make stock more affordable to a wider range of investors Disclose in notes

39 Stockholders’ Equity: Common stock, $10 par, 5,000 shares $ 50,000 Additional paid-in cap. 30,000 Retained earnings 70,000 Total$ 150,000 Before Split 2-for-1 Stock Split Example Assume Shah Company declares 2-for-1 stock split.

40 Stockholders’ Equity: Common stock, $5.00 par, 10,000 shares $ 50,000$ 50,000 Additional paid-in cap. 30,000 30,000 Retained earnings 70,000 70,000 Total$ 150,000$150,000 BeforeAfter All accounts are unchanged 2-for-1 Stock Split Example Only disclosures are affected

41 Statement of Stockholders’ Equity l Shows changes in all equity accounts including »Sales and Purchases of capital stock l Includes: Statement of Retained Earnings Beginning retained earnings Add: Net income Subtract: Dividends = Ending retained earnings

42 Statement of Comprehensive Income Income Statement For Year Ended Dec. 31, 20xx Revenues xxx Expenses xxx Other gains and losses xxx Income before tax xxx Income tax expense xxx Net income xxx Statement of Comprehensive Income For Year Ended Dec. 31, 20xx Net incomexxx Foreign currency translation adjustmentxxx Unrealized holding gains/lossesxxx Minimum pension liability adjustmentxxx Other comprehensive incomexxx Comprehensive incomexxx Comprehensive income – the total change in net assets from all sources except investments by or distributions to the owners

43 Analyzing Owners’ Equity l Book value per share » rights of each share to net assets of corporation l Market value per share » price at which stock is currently selling

44 Book Value per Share l Rights of common stockholders in event of liquidation l Generally represents “floor” price of stock Total Common Stockholders’ Equity # of Common Shares Outstanding

45 Book Value vs. Market Value Which value would you expect to pay for a share of Wrigley stock? What factors account for the difference between the two values? From Delta's 2001 annual report: Book value per share: $26.91 Market value per share in 2001: $38.24 (avg.)

Stockholders’ Equity Items on the Statement of Cash Flows Operating Activities Net income xxx Investing Activities Financing Activities Issuance of stock + Retirement or repurchase of stock - Payment of dividends - 46

47 Appendix Accounting Tools: Unincorporated Businesses

48 Sole Proprietorships l Not a separate legal entity so owner has unlimited liability l Must keep personal and business records separate l Business income is declared on the owner’s personal tax return and taxed at personal tax rate

49 Sole Proprietorships Owner’s withdrawal of assets from business: Peter Tom, Drawing6,000 Equipment 6,000 Owners’ drawing or withdrawal accounts are contra-equity accounts

50 Sole Proprietorships l Drawing or withdrawal and income summary accounts are closed to the owner’s capital account l Owner’s Equity section of the balance sheet consists of the capital account: Beginning balance$ 0 Plus: Investments 10,000 Net Income 4,000 Less: Withdrawals (6,000) Ending balance $ 8,000

51 Partnerships l Unlimited liability l Limited life – partnership agreements can and do end l Not taxed as a separate entity

52 Partnerships Distribution of income: l Equal distribution l Stated ratio l Other allocation »For example, based on salaries, interest on invested capital, and a stated ratio

53 End of Chapter 12 Certificate of Stock