10-1 ©2006 Prentice Hall, Inc.

10-2 ©2006 Prentice Hall, Inc. REPORTING & UNDERSTANDING SHAREHOLDERS’ EQUITY (1 of 2)  Learning objectives Learning objectives  Contributed capital Contributed capital  Cash dividends Cash dividends  Treasury stock Treasury stock  Stock dividends and stock splits Stock dividends and stock splits

10-3 ©2006 Prentice Hall, Inc. REPORTING & UNDERSTANDING SHAREHOLDERS’ EQUITY (2 of 2)  Retained earnings Retained earnings  Financial statement analysis Financial statement analysis  Business risk, control, and ethics Business risk, control, and ethics

10-4 ©2006 Prentice Hall, Inc. Learning Objectives (1 of 3)  Explain how a company finances its business with equity  Account for the payment of cash dividends and calculate the allocation of dividends between common and preferred shareholders

10-5 ©2006 Prentice Hall, Inc. Learning Objectives (2 of 3)  Define treasury stock, explain why a company would purchase treasury stock, and account for its purchase  Explain stock dividends and stock splits  Define retained earnings and account for its increases and decreases

10-6 ©2006 Prentice Hall, Inc. Learning Objectives (3 of 3)  Compute return on equity and earnings per share, and explain what these ratios mean  Recognize the business risks associated with equity and the related controls

10-7 ©2006 Prentice Hall, Inc. Contributed Capital  Three general forms of business  Sole proprietorships  Partnerships  Corporations  Stock—authorized, issued, & outstanding Stock—authorized, issued, & outstanding  Common stock Common stock  Preferred stock Preferred stock

10-8 ©2006 Prentice Hall, Inc. Stock—Authorized Issued and Outstanding (1 of 2)  Authorized shares  Maximum # of shares of stock a corp is authorized to offer to the public  Specified in the corporate charter  Issues shares  Shares of stock that have been offered and sold to shareholders

10-9 ©2006 Prentice Hall, Inc. Stock—Authorized Issued and Outstanding (2 of 2)  Outstanding shares  Issued shares of stock owned by shareholders rather than the corp  Treasury stock  Stock that a corp buys back from shareholders  Outstanding shares = shares issued less treasury stock

10-10 ©2006 Prentice Hall, Inc. Common Stock (1 of 3)  Owners’ rights  Vote for board of directors  Share in pro rata portion of corp profits  Dividends  Share in assets in bankruptcy after creditors and preferred shareholders  Right to acquire more shares when corp issues new shares  Pre-emptive right

10-11 ©2006 Prentice Hall, Inc. Common Stock (2 of 3)  Par value  Arbitrary amount, usually small, and has no real meaning in today’s business environment  Not required by most states  Excess of stock issue proceeds above par value increases Additional Paid-in Capital account

10-12 ©2006 Prentice Hall, Inc. Common Stock (3 of 3)  Caffinators Coffee issued 500 shares of $1 par value stock for $8 per share DateTransactionDebitCredit Assets = Liab. + Cont. Cap. + R/E

10-13 ©2006 Prentice Hall, Inc. Preferred Stock  Owners receive dividends before common shareholders  Priority claim on assets over common shareholders in bankruptcy  Usually do not have voting rights

10-14 ©2006 Prentice Hall, Inc. Cash Dividends  Distributions of earnings to owners  Board of directors decide amount and dates of dividend distributions  Important dividend-related dates Important dividend-related dates  Distribution of dividends between common and preferred shareholders Distribution of dividends between common and preferred shareholders  Dividend payment example Dividend payment example

10-15 ©2006 Prentice Hall, Inc. Important Dividend-related Dates (1 of 2)  Declaration date  Date Board of directors decides it will pay a dividend  Legal obligation to pay dividends is created, giving rise to Dividends Payable and increases Dividends (contra-equity)

10-16 ©2006 Prentice Hall, Inc. Important Dividend-related Dates (2 of 2)  Date of record  All shareholders on date of record entitled to receive dividends  Purchaser of stock after this date will not receive the dividend declared  Payment date  Date dividend actually paid,  Decreases cash and Dividends Payable

10-17 ©2006 Prentice Hall, Inc. Distribution of Dividends Between Common & Preferred Shareholders  Cumulative preferred stock  Shareholders must receive any past, unpaid dividends (dividends in arrears) before a company can pay current dividends to common shareholders  Noncumulative preferred stock  Past, unpaid dividends do not accumulate to preferred shareholders

10-18 ©2006 Prentice Hall, Inc. Dividend Payment Example (1 of 6)  Caffinators Coffee (CC) has the following stock outstanding on 1/1/2008  100 shares of 8% 100 par, cumulative preferred stock  20,000 shares of $1/share common stock  CC has not paid a dividend since 2005

10-19 ©2006 Prentice Hall, Inc. Dividend Payment Example (2 of 6)  On 10/31/08 CC declared $5,000 annual dividends to be paid 11/15/08 to shareholders of record on 10/15/08  Annual dividend for preferred shareholders  100 shares x 8% x $100 = $800  Total dividends payable to preferred shareholders  3 years ( ) x $800 = $2,400

10-20 ©2006 Prentice Hall, Inc. Dividend Payment Example (3 of 6)  Dividends payable to common shareholders  $5,000 - $2,400 = $2,600  Dividend per share  $2,600/20,000 shares = $0.13/share

10-21 ©2006 Prentice Hall, Inc. Dividend Payment Example (4 of 6)  Record the dividend declaration DateTransactionDebitCredit 10/31/08 Assets = Liab. + Cont. Cap. + R/E

10-22 ©2006 Prentice Hall, Inc. Dividend Payment Example (5 of 6)  Record the dividend payment DateTransactionDebitCredit 11/15/08 Assets = Liab. + Cont. Cap. + R/E

10-23 ©2006 Prentice Hall, Inc. Dividend Payment Example (6 of 6)  Assume the pref stock is noncumulative? DateTransactionDebitCredit 10/31/08 11/15/08 Assets = Liab. + Cont. Cap. + R/E

10-24 ©2006 Prentice Hall, Inc. Treasury Stock  Stock a company purchases on the open market  Why firms buy their own stock Why firms buy their own stock  Accounting for treasury stock purchase Accounting for treasury stock purchase  Selling treasury stock Selling treasury stock  Reporting treasury stock Reporting treasury stock

10-25 ©2006 Prentice Hall, Inc. Why Firms Buy Their Own Stock (1 of 3)  Have stock to distribute to employees for compensation plans  Use excess cash to increase shareholder wealth  To return cash to the shareholders if they choose to sell shares to the firm  More flexible for firm and shareholders than paying cash dividends

10-26 ©2006 Prentice Hall, Inc. Why Firms Buy Their Own Stock (2 of 3)  Reduce equity  Treasury stock is contra-equity account  Increase the company’s earnings per share (EPS)  EPS = Net income / # shares outstanding  How does buyback affect interest income?  How does buyback affect # of shares?

10-27 ©2006 Prentice Hall, Inc. Why Firms Buy Their Own Stock (3 of 3)  To reduce the cash needed to pay future dividends  How does this work?  To reduce chances of a hostile takeover  What makes a company an attractive target for a hostile takeover?  Stock repurchase program disclosed in notes to financial statements

10-28 ©2006 Prentice Hall, Inc. Accounting for Treasury Stock Purchase (1 of 2)  Treasury stock accounted for at cost  Separate treasury stock accounts for common and preferred stock  No gain or loss reported on purchase or sale of treasury stock  If a firm sells its treasury stock for more than the purchase price, in which account would it go? Why?

10-29 ©2006 Prentice Hall, Inc. Accounting for Treasury Stock Purchase (2 of 2)  CC repurchased 50 shares for $15/share  It believed its stock was undervalued DateTransactionDebitCredit Assets = Liab. + Cont. Cap. + R/E

10-30 ©2006 Prentice Hall, Inc. Selling Treasury Stock (1 of 3)  Treasury stock account reduced by the cost of the shares sold  How do you reduce a contra-equity account?  Sales price > acquisition cost  Excess increases Paid-in-capital-TS  Sales price < acquisition cost  Decrease Paid-in-capital account

10-31 ©2006 Prentice Hall, Inc. Selling Treasury Stock (2 of 3)  CC sold the 25 shares of its treasury stock for $18/share DateTransactionDebitCredit Assets = Liab. + Cont. Cap. + R/E

10-32 ©2006 Prentice Hall, Inc. Selling Treasury Stock (3 of 3)  CC sold the other 25 shares of its treasury stock for $12/share DateTransactionDebitCredit Assets = Liab. + Cont. Cap. + R/E

10-33 ©2006 Prentice Hall, Inc. Reporting Treasury Stock  Treasury stock, a contra-equity account, is reported as a reduction to stockholders equity  Why aren’t gains and losses reported on the income statement?

10-34 ©2006 Prentice Hall, Inc. Stock Dividends and Stock Splits (1 of 4)  Stock dividends  Distribution of stock instead of cash to shareholders  Capitalizing earnings  Like using retained earnings to issue new shares  Reduce Retained Earnings  Increase Common Stock  Increase Additional Paid in Capital

10-35 ©2006 Prentice Hall, Inc. Stock Dividends and Stock Splits (2 of 4)  CC declares 10% stock dividend on its 500 shares, $1 par, mkt value $14/sh DateTransactionDebitCredit Assets = Liab. + Cont. Cap. + R/E

10-36 ©2006 Prentice Hall, Inc. Stock Dividends and Stock Splits (3 of 4)  Stock split  Split original shares into two or more shares  Why would a firm split its stock?  No accounts are affected by stock split  Par value decreases so total par value is the same ([par value per share] x [# of shares])  Total shares outstanding increases

10-37 ©2006 Prentice Hall, Inc. Stock Dividends and Stock Splits (4 of 4)  CC did a 5 for 1 stock split on its 500 shares of $1 par stock  How many shares will be outstanding after the stock split?  What will the new par value be?  If market value before the split was $10/share, what should be the market value/share after the split?  Is this usually the case?

10-38 ©2006 Prentice Hall, Inc. Retained Earnings  What is the affect of the following on retained earnings?  Net income  Net loss  Dividends  Statement of retained earnings  Shows activity in retained earnings for the period

10-39 ©2006 Prentice Hall, Inc. Financial Statement Analysis (1 of 3)  Return on equity (ROE)  Measures return to common shareholders Net income – preferred dividends _ Average common shareholders’ equity  Why are preferred dividends subtracted from net income?  How does ROA compare to ROE?  Numerator? Denominator?

10-40 ©2006 Prentice Hall, Inc. Financial Statement Analysis (2 of 3)  Earnings per share (EPS)  Measures return to common shareholders Net income – preferred dividends _ Weighted avg # shares outstanding  Basic earnings per share  Assumes no securities that could be converted into common stock are converted

10-41 ©2006 Prentice Hall, Inc. Financial Statement Analysis (3 of 3)  Earnings per share (continued)  Diluted earnings per share  Assumes all securities that could be converted into common stock are converted  Which EPS will be greater, basic or diluted EPS?  Why is a comparison of EPS between firms not meaningful?

10-42 ©2006 Prentice Hall, Inc. Business Risk Control and Ethics (1 of 2)  Risks faced by owners  Stock may decrease in value or become worthless  How can investors reduce the risk of stock ownership?  Why do some companies choose to be publicly traded?

10-43 ©2006 Prentice Hall, Inc. Business Risk Control and Ethics (2 of 2)  Why have many publicly traded companies decided to go private after 2002?  How can a stockholder earn a return on their investment if the company does not pay dividends?

Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business ©2006 Prentice Hall, Inc.