11 Reporting and Analyzing Stockholders’ Equity

11 Reporting and Analyzing Stockholders’ Equity
Kimmel ● Weygandt ● Kieso Financial Accounting, Eighth Edition

1 2 3 4 CHAPTER OUTLINE LEARNING OBJECTIVES
Discuss the major characteristics of a corporation. 1 Explain how to account for the issuance of common and preferred stock, and the purchase of treasury stock. 2 Explain how to account for cash dividends and describe the effect of stock dividends and stock splits. 3 Discuss how stockholders’ equity is reported and analyzed. 4

1 An entity separate and distinct from its owners.
Discuss the major characteristics of a corporation. LEARNING OBJECTIVE 1 An entity separate and distinct from its owners. Classified by Purpose Not-for-Profit For Profit Classified by Ownership Publicly held Privately held Salvation Army American Cancer Society Facebook IBM Caterpillar General Electric Cargill Inc. LO 1

CHARACTERISTICS OF A CORPORATION
Characteristics that distinguish corporations from proprietorships and partnerships. Separate Legal Existence Limited Liability of Stockholders Transferable Ownership Rights Ability to Acquire Capital Continuous Life Corporation Management Government Regulations Additional Taxes Advantages Disadvantages LO 1

Characteristics that distinguish corporations from proprietorships and partnerships. Corporation acts under its own name rather than in the name of its stockholders. Separate Legal Existence Limited Liability of Stockholders Transferable Ownership Rights Ability to Acquire Capital Continuous Life Corporation Management Government Regulations Additional Taxes LO 1

Limited to their investment.
CHARACTERISTICS OF A CORPORATION Characteristics that distinguish corporations from proprietorships and partnerships. Separate Legal Existence Limited Liability of Stockholders Transferable Ownership Rights Ability to Acquire Capital Continuous Life Corporation Management Government Regulations Additional Taxes Limited to their investment. LO 1

Shareholders may sell their stock.
CHARACTERISTICS OF A CORPORATION Characteristics that distinguish corporations from proprietorships and partnerships. Separate Legal Existence Limited Liability of Stockholders Transferable Ownership Rights Ability to Acquire Capital Continuous Life Corporation Management Government Regulations Additional Taxes Shareholders may sell their stock. LO 1

Corporation can obtain capital through the issuance of stock.
CHARACTERISTICS OF A CORPORATION Characteristics that distinguish corporations from proprietorships and partnerships. Separate Legal Existence Limited Liability of Stockholders Transferable Ownership Rights Ability to Acquire Capital Continuous Life Corporation Management Government Regulations Additional Taxes Corporation can obtain capital through the issuance of stock. LO 1

Characteristics that distinguish corporations from proprietorships and partnerships. Separate Legal Existence Limited Liability of Stockholders Transferable Ownership Rights Ability to Acquire Capital Continuous Life Corporation Management Government Regulations Additional Taxes Continuance as a going concern is not affected by the withdrawal, death, or incapacity of a stockholder, employee, or officer. LO 1

Characteristics that distinguish corporations from proprietorships and partnerships. Separate Legal Existence Limited Liability of Stockholders Transferable Ownership Rights Ability to Acquire Capital Continuous Life Corporation Management Government Regulations Additional Taxes Separation of ownership and management prevents owners from having an active role in managing the company. LO 1

Characteristics that distinguish corporations from proprietorships and partnerships. Separate Legal Existence Limited Liability of Stockholders Transferable Ownership Rights Ability to Acquire Capital Continuous Life Corporation Management Government Regulations Additional Taxes LO 1

Characteristics that distinguish corporations from proprietorships and partnerships. Separate Legal Existence Limited Liability of Stockholders Transferable Ownership Rights Ability to Acquire Capital Continuous Life Corporation Management Government Regulations Additional Taxes Corporations pay income taxes as a separate legal entity and in addition, stockholders pay taxes on cash dividends. LO 1

Stockholders ILLUSTRATION 11-1 Corporation organization chart Chairman and Board of Directors President and Chief Executive Officer General Counsel/ Secretary Vice President Marketing Vice President Finance/Chief Financial Officer Vice President Operations Vice President Human Resources Treasurer Controller LO 1

Other Forms of Business Organization
Limited partnerships Limited liability partnerships (LLPs) Limited liability companies (LLCs) S Corporation No double taxation. Cannot have more than 100 shareholders. LO 1

FORMING A CORPORATION Initial Steps:
File application with the Secretary of State. State grants charter. Corporation develops by-laws. Companies generally incorporate in a state whose laws are favorable to the corporate form of business (Delaware, New Jersey). Corporations engaged in interstate commerce must obtain a license from each state in which they do business. LO 1

STOCKHOLDER RIGHTS 1. Vote in election of board of directors and on actions that require stockholder approval. 2. Share the corporate earnings through receipt of dividends. ILLUSTRATION 11-3 Ownership rights of stockholders LO 1

STOCKHOLDER RIGHTS 3. Keep the same percentage ownership when new shares of stock are issued (preemptive right). ILLUSTRATION 11-3 Ownership rights of stockholders LO 1

STOCKHOLDER RIGHTS 4. Share in assets upon liquidation in proportion to their holdings. This is called a residual claim. ILLUSTRATION 11-3 Ownership rights of stockholders LO 1

Signatures of corporate officials
STOCKHOLDER RIGHTS ILLUSTRATION 11-4 A stock certificate Prenumbered Shares Name of corporation Stockholder’s name Signatures of corporate officials

STOCK ISSUE CONSIDERATIONS
Authorized Stock Charter indicates the amount of stock that a corporation is authorized to sell. Number of authorized shares is often reported in the stockholders’ equity section. LO 1

Issuance of Stock Corporation can issue common stock directly to investors or indirectly through an investment banking firm. Top five exchanges by value of shares traded: New York Stock Exchange Nasdaq stock market London Stock Exchange Tokyo Stock Exchange Euronext LO 1

Par and No-Par Value Stocks Par value stock is capital stock that has been assigned a value per share. Years ago, par value determined the legal capital per share that a company must retain in the business for the protection of corporate creditors. Many states do not require a par value. No-par value stock is fairly common. In many states the board of directors assigns a stated value to no-par shares. LO 1

Review Question Which of these statements is false? Ownership of common stock gives the owner a voting right. The stockholders’ equity section begins with paid-in capital. The authorization of capital stock does not result in a formal accounting entry. Legal capital is intended to protect stockholders. LO 1

Paid-in Capital in Excess of Par Two Primary Sources of Equity
CORPORATE CAPITAL Common Stock Account Paid-in Capital Paid-in Capital in Excess of Par Account Preferred Stock Account Two Primary Sources of Equity Retained Earnings Account Paid-in capital is the total amount of cash and other assets paid in to the corporation by stockholders in exchange for shares of ownership. LO 1

CORPORATE CAPITAL Common Stock Account Paid-in Capital Paid-in Capital in Excess of Par Account Preferred Stock Account Two Primary Sources of Equity Retained Earnings Account Retained earnings is net income that a corporation retains for future use in the business. LO 1

1 DO IT! Corporate Organization False True False False False
Indicate whether each of the following statements is true or false. Similar to partners in a partnership, stockholders of a corporation have unlimited liability. It is relatively easy for a corporation to obtain capital through the issuance of stock. The separation of ownership and management is an advantage of the corporate form of business. The journal entry to record the authorization of capital stock includes a credit to the appropriate capital stock account. All states require a par value per share for capital stock. False True False False False LO 1

2 ACCOUNTING FOR COMMON STOCK Primary objectives:
Explain how to account for the issuance of common and preferred stock, and the purchase of treasury stock. LEARNING OBJECTIVE 2 ACCOUNTING FOR COMMON STOCK Primary objectives: Identify the specific sources of paid-in capital. Maintain the distinction between paid-in capital and retained earnings. Other than consideration received, the issuance of common stock affects only paid-in capital accounts. LO 2

Issuing Par Value Common Stock for Cash
Illustration: Assume that Hydro-Slide, Inc. issues 2,000 shares of $1 par value common stock. Prepare Hydro-Slide’s journal entry if (a) 1,000 share are issued for $1 per share, and (b) 1,000 shares are issued for $5 per share. (a) Cash 1,000 Common Stock (1,000 x $1) 1,000 (b) Cash 5,000 Common Stock (1,000 x $1) 1,000 Paid-in Capital in Excess of Par Value 4,000 LO 2

Issuing Par Value Common Stock for Cash
Stockholders’ equity section assuming Hydro-Slide, Inc. has retained earnings of $27,000. ILLUSTRATION 11-5 Stockholders’ equity—paid-in capital in excess of par value LO 2

Review Question ABC Corp. issues 1,000 shares of $10 par value common stock at $12 per share. When the transaction is recorded, credits are made to: Common Stock $10,000 and Paid-in Capital in Excess of Stated Value $2,000. Common Stock $12,000. Common Stock $10,000 and Paid-in Capital in Excess of Par Value $2,000. Common Stock $10,000 and Retained Earnings $2,000. LO 2

ACCOUNTING FOR PREFERRED STOCK
Typically, preferred stockholders have a priority in relation to dividends and assets in the event of liquidation. However, they sometimes do not have voting rights. Each paid-in capital account title should identify the stock to which it relates: Paid-in Capital in Excess of Par Value—Preferred Stock Paid-in Capital in Excess of Par Value—Common Stock LO 2

Preferred stock may have a par value or no-par value.
ACCOUNTING FOR PREFERRED STOCK Illustration: Stine Corporation issues 10,000 shares of $10 par value preferred stock for $12 cash per share. Journalize the issuance of the preferred stock. Cash 120,000 Preferred Stock (10,000 x $10) ,000 Paid-in Capital in Excess of Par – Preferred Stock 20,000 Preferred stock may have a par value or no-par value. LO 2

DO IT! 2 Issuance of Stock Cayman Corporation begins operations on March 1 by issuing 100,000 shares of $1 par value common stock for cash at $12 per share. On March 28, Cayman issues 1,500 shares of $10 par value preferred stock for cash at $30 per share. Journalize the issuance of the common and preferred shares. Mar. 1 Cash 1,200,000 Common Stock (100,000 × $1) 100,000 Paid-in Capital in Excess of Par Value— Common Stock 1,100,000 Mar. 28 Cash 45,000 Preferred Stock (1,500 × $10) 15,000 Paid-in Capital in Excess of Par Value— Preferred Stock 30,000 LO 2

TREASURY STOCK Common Stock Account Paid-in Capital Paid-in Capital in Excess of Par Account Preferred Stock Account Two Primary Sources of Equity Retained Earnings Account Less: Treasury Stock Account LO 2

TREASURY STOCK Treasury stock is a corporation’s own stock that has been reacquired by the corporation and is being held for future use. Corporations purchase their outstanding stock: To reissue shares to officers and employees under bonus and stock compensation plans. To increase trading of the company’s stock in the securities market. To have additional shares available for use in acquiring other companies. To increase earnings per share. Another infrequent reason is to eliminate hostile shareholders. LO 2

TREASURY STOCK Purchase of Treasury Stock
Generally accounted for by the cost method. Debit Treasury Stock for the price paid. Treasury stock is a contra stockholders’ equity account, not an asset. Treasury Stock decreases by the same amount when the company later sells the shares. LO 2

Purchase of Treasury Stock
ILLUSTRATION 11-6 Stockholders’ equity with no treasury stock Illustration: On February 1, 2017, Mead acquires 4,000 shares of its stock at $8 per share. Prepare the entry. Treasury Stock (4,000 x $8) 32,000 Cash 32,000 LO 2

ILLUSTRATION 11-7 Stockholders’ equity with treasury stock Both the number of shares issued (100,000), outstanding (96,000), and the number of shares held as treasury (4,000) are disclosed. LO 2

Review Question Treasury stock may be repurchased: to reissue the shares to officers and employees under bonus and stock compensation plans. to signal to the stock market that management believes the stock is underpriced. to have additional shares available for use in the acquisition of other companies. More than one of the above. LO 2

2b DO IT! Treasury Stock Santa Anita Inc. purchases 3,000 shares of its $50 par value common stock for $180,000 cash on July 1. It expects to hold the shares in the treasury until resold. Journalize the treasury stock transaction. July 1 Treasury Stock 180,000 Cash 180,000 LO 2

Explain how to account for cash dividends and describe the effect of stock dividends and stock splits. LEARNING OBJECTIVE 3 A dividend is a distribution to stockholders on a pro rata (proportional to ownership) basis. Types of Dividends: Cash dividends. Property dividends. Stock dividends. Scrip (promissory note) Dividends expressed: (1) as a percentage of the par or stated value, or (2) as a dollar amount per share. LO 3

CASH DIVIDENDS For a corporation to pay a cash dividend, it must have:
Retained earnings - Payment of dividends from retained earnings is legal in all states. Adequate cash. Declaration by the Board of Directors. LO 3

Entries for Cash Dividends
Dividends require information concerning three dates: LO 3

Illustration: On December 1, the directors of Media General declare a $0.50 per share cash dividend on 100,000 shares of $10 par value common stock. The dividend is payable on January 20 to shareholders of record on December 22: December 1 (Declaration Date) Cash Dividends 50,000 Dividends Payable 50,000 December 22 (Record Date) No entry January 20 (Payment Date) Dividends Payable 50,000 Cash 50,000 LO 3

Review Question Entries for cash dividends are required on the: declaration date and the record date. record date and the payment date. declaration date, record date, and payment date. declaration date and the payment date. LO 3

DIVIDEND PREFERENCES Preferred stockholders have the right to receive dividends before common stockholders. Per share dividend amount is stated as a percentage of the preferred stock’s par value or as a specified amount. Cumulative dividend – holders of preferred stock must be paid their annual dividend plus any dividends in arrears before common stockholders receive dividends. Preference on corporate assets if the corporation fails. Preference may be for the par value of the shares or for a specified liquidating value. LO 3

Cumulative Preferences
Illustration: Scientific Leasing has 5,000 shares of 7%, $100 par value, cumulative preferred stock outstanding. Each $100 share pays a $7 dividend (.07 x $100). The annual dividend is $35,000 (5,000 x $7 per share). If dividends are two years in arrears, preferred stockholders are entitled to receive the following dividends in the current year. Dividends in arrears ($35,000 × 2) $ 70,000 Current-year dividends 35,000 Total preferred dividends $105,000 ILLUSTRATION 11-8 Computation of total dividends to preferred stock LO 3

Cumulative Preferences
Review Question U-Bet Corporation has 10,000 shares of 8%, $100 par value, cumulative preferred stock outstanding at December 31, No dividends were declared in 2015 or If U- Bet wants to pay $375,000 of dividends in 2017, common stockholders will receive: $0. $295,000. $215,000. $135,000. LO 3

3a DO IT! Preferred Stock Dividends
MasterMind Corporation has 2,000 shares of 6%, $100 par value preferred stock outstanding at December 31, At December 31, 2017, the company declared a $60,000 cash dividend. Determine the dividend paid to preferred stockholders and common stockholders under each of the following scenarios. The preferred stock is noncumulative, and the company has not missed any dividends in previous years. SOLUTION Preferred stockholders (2,000 x .06 x $100) $ 12,000 Common stockholders ($60,000 - $12,000) 48,000 Total dividends $60,000 LO 3

MasterMind Corporation has 2,000 shares of 6%, $100 par value preferred stock outstanding at December 31, At December 31, 2017, the company declared a $60,000 cash dividend. Determine the dividend paid to preferred stockholders and common stockholders under each of the following scenarios. The preferred stock is noncumulative, and the company did not pay a dividend in each of the two previous years. SOLUTION Preferred stockholders (2,000 x .06 x $100) $ 12,000 Common stockholders ($60,000 - $12,000) 48,000 Total dividends $60,000 LO 3

MasterMind Corporation has 2,000 shares of 6%, $100 par value preferred stock outstanding at December 31, At December 31, 2017, the company declared a $60,000 cash dividend. Determine the dividend paid to preferred stockholders and common stockholders under each of the following scenarios. The preferred stock is cumulative, and the company did not pay a dividend in each of the two previous years. SOLUTION Preferred stockholders (3 x 2,000 x .06 x $100) $ 36,000 Common stockholders ($60,000 - $36,000) 24,000 Total dividends $60,000 LO 3

STOCK DIVIDENDS Pro rata distribution of the corporation’s own stock.
ILLUSTRATION 11-10 Effect of stock split for stockholders LO 3

STOCK DIVIDENDS Pro rata distribution of the corporation’s own stock.
Results in decrease in retained earnings and increase in paid-in capital. Reasons why corporations issue stock dividends: Satisfy stockholders’ dividend expectations without spending cash. Increase the marketability of the corporation’s stock. Emphasize that a portion of stockholders’ equity has been permanently reinvested in the business. LO 3

Effects of Stock Dividends
Changes the composition of stockholders’ equity. Total stockholders’ equity remains the same. No effect on the par or stated value per share. Increases the number of shares outstanding. LO 3

Effects of Stock Dividends
Illustration: Medland Corp. declares a 10% stock dividend on its $10 par common stock when 50,000 shares were outstanding. The market price was $15 per share. ILLUSTRATION 11-9 Stock dividend effects LO 3

STOCK SPLITS Reduces the market value of shares.
▼ HELPFUL HINT A stock split changes the par value per share but does not affect any balances in stockholders’ equity. Reduces the market value of shares. No entry recorded for a stock split. Decrease par value and increase number of shares. ILLUSTRATION 11-10 Effect of stock split for stockholders LO 3

STOCK SPLITS Illustration: Assuming that instead of issuing a 10% stock dividend, Medland splits its 50,000 shares of common stock on a 2-for-1 basis. ILLUSTRATION 11-11 Stock split effects LO 3

STOCK DIVIDENDS vs STOCK SPLITS
Differences between the effects of stock dividends and stock splits. ILLUSTRATION 11-12 Effects of stock splits and stock dividends differentiated LO 3

STOCK DIVIDENDS Review Question
Which of these statements about stock dividends is true? Stock dividends reduce a company’s cash balance. A stock dividend has no effect on total stockholders’ equity. A stock dividend decreases total stockholders’ equity. A stock dividend ordinarily will increase total stockholders’ equity. LO 3

3b DO IT! Stock Dividends; Stock Splits
The market price of Sing CD Corporation’s 500,000 shares of $2 par value common stock is $45. President Joan Elbert is considering either a 10% stock dividend or a 2-for-1 stock split. She asks you to show the before-and-after effects of each option on (a) retained earnings, (b) total stockholders’ equity, and (c) par value per share. Stock dividend amount is $2,250,000 [(500,000 × 10%) × $45]. LO 3

Discuss how stockholders’ equity is reported and analyzed.
LEARNING OBJECTIVE 4 RETAINED EARNINGS Retained earnings is net income that a company retains for use in the business. Net income increases Retained Earnings and a net loss decreases Retained Earnings. Retained earnings is part of the stockholders’ claim on the total assets of the corporation. A debit balance in Retained Earnings is identified as a deficit. LO 4

RETAINED EARNINGS LO 4 ILLUSTRATION 11-14
Stockholders’ equity with deficit LO 4

RETAINED EARNINGS RESTRICTIONS
Restrictions can result from: Legal restrictions. Contractual restrictions. Voluntary restrictions. ILLUSTRATION 11-15 Disclosure of unrestricted retained earnings LO 4

BALANCE SHEET PRESENTATION
Two classifications of paid-in capital: Capital stock Additional paid-in capital Other comprehensive income items include certain adjustments to pension plan assets, types of foreign currency gains and losses, and some gains and losses on investments. LO 4

ILLUSTRATION 11-16 Stockholders’ equity section of balance sheet LO 4

4a DO IT! Stockholders’ Equity Section
Jennifer Corporation has issued 300,000 shares of $3 par value common stock. It is authorized to issue 600,000 shares. The paid-in capital in excess of par value on the common stock is $380,000. The corporation has reacquired 15,000 shares at a cost of $50,000 and is currently holding those shares. It also had a cumulative other comprehensive loss of $82,000. The corporation also has 4,000 shares issued and outstanding of 8%, $100 par value preferred stock. It is authorized to issue 10,000 shares. The paid-in capital in excess of par value on the preferred stock is $97,000. Retained earnings is $610,000. Prepare the stockholders’ equity section of the balance sheet. LO 4

ANALYSIS OF STOCKHOLDERS’ EQUITY
Dividend Record Illustration: The following is the calculation of the payout ratio for Nike in 2014 and 2013. ILLUSTRATION 11-17 Nike’s payout ratio The payout ratio measures the percentage of earnings a company distributes in the form of cash dividends. LO 4

ANALYSIS OF STOCKHOLDERS’ EQUITY
Earnings Performance Illustration: The following is the calculation of Nike’s return on common stockholders’ equity ratios for 2014 and 2013. This ratio shows how many dollars of net income a company earned for each dollar of common stockholders’ equity. LO 4

DEBT VERSUS EQUITY DECISION
ILLUSTRATION 11-20 Advantages of bond financing over common stock LO 4

ILLUSTRATION 11-21 Components of the return on common stockholders’ equity LO 4

Illustration: Microsystems Inc. currently has 100,000 shares of common stock outstanding issued at $25 per share and no debt. It is considering two alternatives for raising an additional $5 million: Plan A involves issuing 200,000 shares of common stock at the current market price of $25 per share. Plan B involves issuing $5 million of 12% bonds at face value. Income before interest and taxes will be $1.5 million; income taxes are expected to be 30%. ILLUSTRATION 11-22 Effects on return on common stockholders’ equity

4b DO IT! Analyzing Stockholders’ Equity
On January 1, 2017, Siena Corporation purchased 2,000 shares of treasury stock. Other information regarding Siena Corporation is provided below. Net income $110,000 $110,000 Dividends on preferred stock $10,000 $10,000 Dividends on common stock $1,600 $2,000 Common stockholders’ equity, beg. of year $400,000* $500,000 Common stockholders’ equity, end of year $400,000 $500,000 *Adjusted for purchase of treasury stock. Compute the return on common stockholders’ equity for each year. LO 4

4b DO IT! Analyzing Stockholders’ Equity 2017 2016
Net income $110,000 $110,000 Dividends on preferred stock $10,000 $10,000 Dividends on common stock $1,600 $2,000 Common stockholders’ equity, beg. of year $400,000* $500,000 Common stockholders’ equity, end of year $400,000 $500,000 *Adjusted for purchase of treasury stock. Compute the return on common stockholders’ equity for each year. LO 4

5 APPENDIX 11A: Prepare entries for stock dividends.
LEARNING OBJECTIVE 5 Illustration: Medland Corporation declares a 10% stock dividend on its 50,000 shares of $10 par value common stock. The current fair market value of its stock is $15 per share. Record the entry on the declaration date: Stock Dividends 75,000 Common Stock Dividends Distributable 50,000 Paid-in Capital in Excess of Par Value 25,000 LO 5

STOCK DIVIDENDS ILLUSTRATION 11A-1 Statement presentation of common stock dividends distributable Illustration: Record the journal entry when Medland issues the dividend shares. Common Stock Dividends Distributable 50,000 Common Stock 50,000 LO 5

11 Reporting and Analyzing Stockholders’ Equity

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