1. Intermediate Accounting
Chapter 15
Contributed Capital
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2. Learning Objectives
Define equity and explain the corporate form of organization, including its advantages and disadvantages.
Know the rights and terms that apply to capital stock.
Account for the issuance of capital stock.
Describe noncompensatory share purchase plans.
Describe and account for share-based compensation plans.
Describe the characteristics of preferred stock.
Understand the accounting for treasury stock.
Know the components of contributed capital and how they are reported in financial statements.

3. Shareholders’ Equity Learning Objective #1
Equity is the residual interest in the assets of a company that remains after deducting its liabilities.
The balance sheet accounting for financing activities by common equity shareholders typically involves:
Contributed capital accounts, such as common equity at par and additional paid-in capital
Earned capital accounts, such as retained earnings and accumulated other comprehensive income
Contributed Capital is the section of shareholders’ equity in which a corporation records the results of all its stock transactions in capital stock accounts and additional paid-in capital accounts.

4. Shareholders’ Equity Provide? (Slide 2 of 2)
What Information Does
Shareholders’ Equity Provide? (Slide 2 of 2)
Contributed Capital is the section of shareholders’ equity in which a corporation records the results of all its stock transactions in capital stock accounts and additional paid-in capital accounts.
Retained Earnings is an account in shareholders’ equity where any net income that has been reinvested in the corporation and not paid out to shareholders as dividends is reported.
Accumulated Other Comprehensive Income is an account in shareholders’ equity where a corporation reports any increase or decrease in shareholders’ equity as a result of other comprehensive income.
A company’s equity changes:
As it earns net income
As it declares dividends
As transactions between the company and its owners occur
As other comprehensive income transactions occur

5. Changes in Equity Accounts

6. How Are Corporations Organized?
Shareholders (or stockholders) are owners of a corporation.
The primary advantage of the corporate form is the ability to raise large amounts of capital by issuing shares of stock.
Limited legal liability is a concept in which owners bear no personal liability for the corporation’s debts and risk; they risk only their capital investment.
Corporations generally pay more taxes than other organization forms because of:
Higher tax rates than other forms
Owners are subject to double taxation
Income earned by the corporation
Dividends distributed to shareholders

7. How Are Corporations Classified? (Slide 1 of 2)
Stock companies issue shares of stock to shareholders and operate for profit:
Open corporations (often called publicly traded corporations) are corporations whose stock can be purchased by any individual on a stock exchange.
Closed corporations (often called privately held corporations) are corporations that do not allow the sale of stock to the general public; some are family owned and shares are not available for purchase by the public.
Public corporations are owned by governmental units.

8. How Are Corporations Classified? (Slide 2 of 2)
Domestic corporations are companies doing business in the state or country in which they are incorporated.
Starbucks, which is incorporated in the State of Washington, is a domestic company with respect to Washington.
Volkswagen is a domestic company of Germany.
Foreign corporations are companies that are operated in a state or nation other than the one in which it is incorporated.
Starbucks is a foreign corporation with regard to the State of North Carolina.

9. How Are Corporations Formed?
In the United States, a corporation is a legal entity of a particular state.
An approved application for incorporation becomes a corporation’s articles of incorporation (or corporate charter).
For a corporation to perform its functions, the state gives it various rights and powers. These include the right to:
Enter into contracts
Hold, buy, and sell property
Sue and be sued
Continue indefinitely

10. Capital Structure of a Corporation Learning Objective #2
A stock certificate is a serially numbered document that indicates the number of shares owned and the par value (if any).
Because stock certificates are easily transferred from one investor to another, state laws require that each corporation keep appropriate records of its shareholders.
A transfer agent (such as a bank) handles the issuance of stock certificates.
A registrar maintains the shareholder records.

11. Capital Stock and Shareholders’ Rights
(Slide 1 of 2)
Capital stock refers to the shares of stock issued by the corporation and owned by its shareholders.
Each shareholder has various rights.
Right to a dividend when it is declared
Right to elect directors and to establish corporate policies (voting right)
Right (called a preemptive right) to maintain a proportionate interest in the ownership of the corporation by purchasing a proportionate (pro rata) share of additional capital stock if more stock is issued
Right to share in the distribution of the assets of the corporation if it is liquidated

12. Capital Stock and Shareholders’ Rights
(Slide 2 of 2)
Common stock is capital stock that carries all of the rights of ownership.
Some corporations issue more than one class of common stock such as Class A and Class B common stock.
In this case, usually one type of common stock has greater voting rights than the other to maintain control over the corporate activities.
Preferred stock is not granted all of the common stock’s rights, but receives in exchange certain other privileges.

13. Basic Terminology
Authorized capital stock is the number of shares of capital stock that a corporation may issue as stated in the corporate charter.
Issued capital stock is the number of shares of capital stock that a corporation has issued to its shareholders as of a specific date.
Outstanding capital stock is the number of shares of capital stock that a corporation issued to shareholders and that are being held by shareholders as of a specific date.
Treasury stock is the number of shares of capital stock issued to and reacquired from shareholders but not retired.
Subscribed capital stock is the number of shares of capital stock that a corporation will issue upon completion of an installment purchase contract with an investor.

14. Legal Capital
To protect the corporation’s creditors, state laws have established the concept of legal capital as the amount of stockholders’ equity that the corporation cannot distribute to shareholders.
The definition of legal capital varies among states;
In most states, the par value or stated value of all its issued stock is the legal capital.

15. Par Value and Stated Value
The par value of a corporation’s capital stock (either common or preferred) is a designated dollar amount per share that is established in the articles of incorporation and is printed on each stock certificate.
The par value of a stock has no relation to its market value.
Stock rarely sells initially for less than its par value, because it is illegal to do so in most states.
No-par capital stock is stock that does not carry a par value. When a corporation issues no-par stock, some states require that the corporation designate the entire proceeds received as legal capital.
Some states allow directors to establish a stated value per share of no-par stock, when multiplied by the number of shares issued, generally determines the amount of the corporation’s legal capital.

16. Additional Paid-in Capital
State law requires the corporation to record the par or stated value.
Additional paid-in capital is the excess value received (the difference between the exchange price and the par or stated value) in each type of stock transaction.
While most companies use the term Additional Paid-in Capital, you may also see the terms:
Capital in Excess of Par (or Stated) Value
Paid-in Capital in Excess of Par (or Stated) Value
Additional Capital

17. Issuance of Capital Stock Learning Objective #3
When a corporation issues only one class of capital stock, it is referred to as common stock.
The corporate charter contains the authorization to issue capital stock. This authorization is recorded in a memorandum journal entry which identifies the number of authorized shares, the par or stated value, and, in the case of preferred stock, any preferred provisions.

18. Accounting for the Issuance of Capital Stock
Example (Issuance for Cash) Powell Corporation issues 500 shares of its $5 par common stock for $16 per share. The corporation’s journal entry for the issuance of stock is shown below.
Cash ($16 × 500) 8,000
Common Stock, $5 par value ($5 × 500) 2,500
Additional Paid-in Capital on Common Stock 5,500
If the stock were no-par stock with a stated value of $5 per share, the corporation would record the preceding transaction in the same way and denote $5 stated value
For both situations, the number of shares issued can be determined as:
Number of Shares Issued =
Total Amount in the Common Stock Account
Par or Stated Value of the Shares

19. Stock Issuance Costs
A corporation may incur miscellaneous costs that arise from issuing its capital stock.
Legal fees
Accounting fees
Stock certificate fees
Underwriter’s fees
Promotional fees
Postage
When these costs are incurred at the initial issuance of stock at the time of incorporation, they are considered an organization expense.

20. Stock Subscriptions
Investors sometimes agree to purchase capital stock from a corporation and pay at a later date.
This creates a legally-binding subscription contract between the corporation and the future shareholders.
This contract requires the investor to buy a certain number of shares at an agreed-upon price, with payment spread over a specified time period.
The contract often requires a down payment and may require the investor to issue the company a promissory note.
The contract will also set forth what will happen if the investor is not able to pay and defaults.

21. Combined Sales of Stock (Slide 1 of 2)
When a corporation issues different types of securities in a combined sale, it allocates the proceeds between the securities based on the relative fair value of each security.
If the fair value of only one of the securities are known, the fair value amount is assigned to that security. The remaining proceeds are assigned to the security with the unknown fair value.
Example Brandt Corporation issues 100 “bundles” of securities for $82.80 per bundle, or a total of $8,280.
Each bundle includes two shares of $10 par common stock and one share of $50 par preferred stock.
The separate fair values are $16 per share for the common stock and $60 per share for the preferred stock.

22. Combined Sales of Stock (Slide 2 of 2)
Brant makes the following journal entry:
Cash 8,280
Common Stock, $10 par (200 shares) 2,000
Additional Paid-in Capital on Common Stock 880
Preferred Stock, $50 par (100 shares) 5,000
Additional Paid-in Capital on Preferred Stock 400
Supporting Computations:
Aggregate Fair Value
Common Stock: $16 × 2 shares × 100 packages = $3,200
Preferred Stock: $60 × 1 share × 100 packages = 6,000
$9,200
Allocation
Common Stock:
$3,200
$9,200
× $8,280 = $2,880
Preferred Stock:
$6,000
× $8,280 = 5,400
$8,280

23. Nonmonetary Issuance of Stock (Slide 1 of 2)
A nonmonetary exchange is any type of transaction in which a corporation issues capital stock for assets other than cash, or for services performed.
The general rule is to record the exchange at the fair value of the stock issued or the asset received, whichever can be measured with greater representational faithfulness.
Example (Fair Value of Stock Known) Capers Corporation issues 200 shares of $10 par common stock for a patent. The stock is currently selling for $22 per share on the open market. Caper records the following transaction:
Patent ($22 × 200) 4,400
Common Stock, $10 par 2,000
Additional Paid-in Capital on Common Stock 2,400

24. Nonmonetary Issuance of Stock (Slide 2 of 2)
Stock may be closely held and not actively traded. The fair value of the assets received may provide a more representationally faithful value of the transaction.
Example (Fair Value of Asset Known) Eli Corporation issues 500 shares of $8 par common stock that is not widely traded for an acre of land.
An independent appraiser indicates the land is worth $20,000. The transaction would be recorded as follows:
Land ($22 × 200) 20,000
Common Stock, $10 par 2,000
Additional Paid-in Capital on Common Stock 18,000

25. Stock Splits (Slide 1 of 2)
To reduce the market price of a corporation’s stock so that it falls within a desired “trading range” of most investors, a corporation may authorize a stock split.
A stock split is proportionally decreases in market price and par value per share of stock and increases the number of shares issued.
A stock split also results in a proportional increase in the number of shares authorized.
A reverse split increases the par value per share and proportionally decreases the number of shares issued.

26. Stock Splits (Slide 2 of 2)
Example Angie Corporation has 250,000 authorized shares and has issued 60,000 shares of $10 par common stock.
Angie declares a two-for-one stock split with a reduction to a $5 par value.
After the split, 500,000 shares are authorized, and a total of 120,000 shares of $5 common stock are issued.
A corporation records a stock split by a memorandum entry that indicates the new par value, the total number of shares issued, and the impact on the number of authorized shares.

27. Stock Warrants (Slide 1 of 3)
Stock warrants represent the right to purchase additional shares of common stock at an established price, or exercise price.
Exercise price (or strike price) is the price at which the holder of an option or warrant has the right to buy or sell the common stock.
Detachable warrants are warrants that can be separated from the other security and traded independently.
Example Rehage Company issues 1,000 shares of $50 par preferred stock with detachable warrants for $106,000 on January 1, 2016.
Each share of preferred stock is issued with 5 detachable warrants. Each warrant entitles the holder to purchase one share of common stock for $50. The warrants expire in 2 years.

28. Stock Warrants (Slide 2 of 3)
The fair market value of the preferred stock is $72,000 on January 1, 2016, and the warrants sell for $8 per warrant. Rehage makes the following journal entry:
Cash 106,000.00
Preferred Stock 50,000.00
Additional Paid-in Capital on
Preferred Stock 18,142.86
Paid-in Capital—Common Stock
Warrants 37,857.14
Aggregate Fair Value
Preferred Stock $ 72,000
Common Stock Warrants = 5,000 warrants × $8 = ,000
$112,000
Allocation
Preferred Stock ($72,000/$112,000) × $106,000 = $68,142.86
Common Stock Warrants ($40,000/$112,000) × $106,000 = $37,857.14

29. Stock Warrants (Slide 3 of 3)
On July 1, 2016, the warrants are exercised to purchase common stock (with a par value of $10 per share). The exercise price is $50 per share. Rehage should make the following entry:
Cash (5,000 warrants × $50) 250,000.00
Paid-in Capital—Common Stock Warrants 37,857.14
Common Stock (5,000 × $10 par value) ,000.00
Additional Paid-in Capital on Common Stock 237,857.14
When the warrants are exercised, the Paid-in Capital— Common Stock Warrants account is eliminated.
Consideration = Cash of $250,000 + Warrants valued at $37,857.14

30. Noncompensatory Share Purchase Plans Learning Objective #4
A noncompensatory share purchase plan enables employees to buy shares of stock, usually at a discount.
Three criteria must be met:
All employees who meet specific employment qualifications may participate in the plan on an equal basis.
The discount from the market price does not exceed stock issuance costs avoided by not issuing the stock to the public.
The plan has no option features other than the following:
Employees are allowed a short time to decide whether to enroll
The purchase price is based solely on the market price of the stock on the purchase date, and employees are permitted to cancel their participation before the purchase date and obtain a refund of any amounts previously paid.

31. Share-Based Compensation Plans Learning Objective #5
A share-based compensation plan is a compensation arrangement in which employees receive share options, shares of stock, or cash payments based on the change in stock price instead of cash bonus.
A compensatory share option plan is an arrangement intended to provide additional compensation by rewarding employees shares in the company or cash bonuses tied to changes in the company’s stock price.
Restricted share awards and appreciation rights are arrangements intended to provide additional compensation by awarding employees shares in the company or cash bonuses tied to changes in the company’s stock price.

32. Overview of Compensatory Share Option Plans
In developing a compensatory share option plan, a company’s objective is to better align the company’s goals with those of management and its owners.
The grant date is the date on which the company provides the share options to the employees.
The intrinsic value method is a method whereby a corporation measures the total options-based compensation cost for each employee as follows:
Total Options-Based Compensation Cost =
Number of Share Options ×
Market Price of the Stock on Date of Grant
Exercise Price of the Share Option ‒

33. Accounting for Share-Based Compensation Plan
In response to the need for high-quality “transparent” financial reporting, the FASB updated the accounting for share-based compensation plan to require the use of the fair value method.

34. How Do We Account for Compensatory Share Option Plans? (Slide 1 of 4)
Option pricing models are used to estimate the fair value of the option.
The option pricing model that a corporation uses must take into account the following variables as of the grant date:
Exercise price
Expected life of the option
Current market price of the underlying common stock
Expected volatility of the stock price
Expected dividends on the stock
Risk-free interest rate for the expected term of the option
An option’s value is determined at the grant date as follows:
Option Value (Fair Value) = Current Stock Price ‒ Present Value of Exercise Price

35. How Do We Account for Compensatory Share Option Plans? (Slide 2 of 4)
The cost recognized by a company for its share-based compensation plan is the total fair value of the share options that actually become vested.
Vested occurs when an employee has fulfilled the service requirement and has ownership of the share options.
If the corporation expects that a significant number of employees will forfeit their options, then it records the compensation expense each year based on an estimate of the number of options expected to vest. The estimated total compensation cost is determined at the grant date as follows:
Estimated Total Compensation Cost =
Fair Value per Option ×
Estimate of the Number of Share Options Expected to Vest

36. How Do We Account for Compensatory Share Option Plans? (Slide 3 of 4)
A fixed share option plan is a plan in which all the terms (e.g., exercise price, number of shares) are set (“fixed”) on the grant date.
Example On January 1, 2016, Fox Corporation adopts a compensatory share option plan and grants 9,000 share options (to acquire 9,000 shares of common stock) with a maximum life of 10 years to 30 selected employees.
The $50 exercise price is equal to the market price of the stock on this grant date. All the options vest at the end of 3 years if the employee is still employed by the company.
Fox expects 10% of the options to be forfeited.

37. How Do We Account for Compensatory Share Option Plans? (Slide 4 of 4)
At the end of 2015, a total of 7,500 share options for 25 employees actually vest, and the other 1,500 are forfeited. Fox determines that the fair value of each option is $18 on the grant date.
The total options-based estimated compensation cost on the grant date for this fixed share option plan is determined as follows:
Total Options-Based Estimated Compensation Cost
= Fair Value per Option
× Number of Options Expected to Vest
= $ × (9,000 × .09)
= $145,800
On January 1, 2016 (the grant date), Fox makes a memorandum entry to summarize the terms of the compensatory share option plan.

38. Fixed Compensatory Share Option Plan
Fox Corporation

39. Performance-Based Option Plans (Slide 1 of 2)
Performance-based share option plans (or variable-term share option plans) are plans in which one or more terms are not fixed at the grant date. These plans are set up so that the terms will vary depending on how well the selected employees perform during the service period.
Example The terms of Fox Corporation’s performance-based plan adopted on January 1, 2016, are the same as in the previous example (3-year vesting and service period, $50 exercise price, and $18 fair value per option) except, Fox grants each of the 30 selected employees a minimum of 300 share options.
The options vest in differing numbers depending on the market share of Fox’s products over the 3-year period.

40. Performance-Based Option Plans (Slide 2 of 2)
Terms of the plan are that by December 31, 2015:
If the market share has increased by at 5%, at least 100 share options will vest for each employee on that date.
If the market share has increased by at least 10%, another 100 share options will vest for each employee, for a total of 200.
If the market share has increased by more than 20%, all 300 share options will vest for each employee.
At the end of 2015, Fox determines that its market share has increased over the 3-year period by more than 20%. In addition, at the end of 2015, 25 employees vest in 7,500 share options.

41. Performance-Based Compensatory Share Option Plan
Fox Corporation

42. Restricted Share Plan (Slide 1 of 4)
Because some employees who qualify to buy shares of stock in a compensatory plan have a cash-flow problem, corporations have developed share-based plans involving restricted shares.
A restricted share plan is a plan in which employees are granted actual shares of stockn.
While the employee becomes an actual shareholder on the date of the grant, the company maintains physical possession of the shares, restricting the employee’s ability to sell the shares until the employee reaches certain goals.

43. Restricted Share Plan (Slide 2 of 4)
Compensation cost for restricted share plans is determined using the fair value method and is calculated as follows:
Total Compensation Cost
Market Price of the Share on Date of Grant
Number of Restricted Shares Awarded = ×
Example On January 3, 2016, Taos Corporation hires a new Director of Accounting.
In addition to salary and other benefits, the employment package grants 10,000 restricted shares of Taos common stock that vest in 3 years if the director is still an employee.

44. Restricted Share Plan (Slide 3 of 4)
On January 3, 2016, the $5 par value common stock is trading at $63 per share. The restricted share award is calculated as:
Total Compensation Cost
Market Price of the Share on Date of Grant
Number of Restricted Shares Awarded = ×
$630, = $ × 10,000 share units
Taos would recognize $210,000 ($630,000 ÷ 3 years) of compensation expense for each of the three required years :
December 31, 2016
Compensation Expense 210,000
Paid-in Capital from Restricted Shares 210,000
If the Director of Accounting is still an employee at the end of 3 years, the shares would vest and no longer be restricted.

45. Restricted Share Plan (Slide 4 of 4)
Taos would issue 10,000 common shares to the employee :
December 31, 2015
Paid-in Capital from Restricted Shares 630,000
Common Stock (10,000 × $5 Par Value) 50,000
Additional Paid-in Capital from Common Stock 580,000
If the Director of Accounting left Taos on March 1, 2015, Taos would make the following journal entry to reverse the 2 years of compensation expense previously recorded.
Paid-in Capital from Restricted Shares 420,000
Compensation Expense 420,000
March 1, 2015

46. Share Appreciation Rights
Share appreciation rights (SARs) are rights granted to selected employees that enable them to receive cash, shares, or a combination of both equal to the excess of the market value over a stated price of the corporation’s stock on the date of exercise.
A company accounts for a SARs plan using the fair value method.
For SARs the fair value can only be determined on the date the rights are exercised.
To record the compensation expense for the SARs plan, an estimate of the total compensation cost is made at the end of each year based on the fair value of the SARs at that time. Adjustments are made after each service period has expired.

47. Recognition of Compensation Cost Under SAR

48. Share Appreciation Rights (Slide 2 of 3)
Example On January 1, 2016, when the market price is $60 per share, Wolf Corporation grants share appreciation rights to a selected employee, Tom Essman.
Under the SAR plan, Tom will receive cash for the difference between the quoted market price and $60 for 1,000 shares of Wolf’s common stock on the date of exercise.
The service period is 4 years and the rights must be exercised within 10 years of the grant date.
On the grant date, Wolf estimates that the fair value of each SAR is $17. Wolf makes a memorandum entry on January 1, 2016, indicating that the estimated fair value of this SAR award is $17,000.

49. Share Appreciation Rights (Slide 3 of 3)
On December 31, 2016, the fair value per SAR is $20.
On that date, Tom exercises the rights when the quoted market price of Wolf’s stock is $94 per share.
Tom’s compensation is calculated:
The journal entry to record the compensation earned in the first year of the four-year period, is:
$20 x 1,000 shares = $20,000
Compensation Expense 5,000
SAR Compensation Payable 5,000

50. SAR Annual Compensation Expense
The journal entry to record the compensation earned in the second year:
Compensation Expense 10,000
SAR Compensation Payable 10,000

51. Characteristics of Preferred Stock Learning Objective #6
Various preferred stock characteristics may be specified in preferred stock contract:
Preference as to dividends
Accumulation of dividends
Participation in excess dividends
Convertibility to common stock
Attachment of stock warrants
Callability by the corporation
Mandatory redemption at a future maturity date
Preference to assets upon liquidation of the corporation
Lack of voting rights

52. Preference as to Dividends
A corporation must pay any applicable dividends to preferred shareholders before a dividend may be paid to common shareholders.
Example Tusker Corporation has outstanding 5,000 shares of 6%, $100 par preferred stock.
Each preferred shareholder is entitled to an $6 (6% × $100) annual dividend per share.
The corporation must pay $30,000 of dividends (6% × $100 × 5,000) to preferred stockholders before it may pay any dividends to common shareholders.
A preference as to dividends does not guarantee that a corporation will pay a preferred dividend in any given year.

53. Cumulative Preferred Stock (Slide 1 of 2)
Noncumulative preferred stock is stock carrying the provision that the holder will never be paid a dividend in a particular year if dividends are not declared in that year.
Cumulative preferred stock is stock carrying the provision that, if a corporation fails to declare a dividend on cumulative preferred stock at the stated rate on the usual dividend date, the amount become dividends in arrears.
Dividends in arrears accumulate from period to period.
Dividends in arrears are not liabilities.
A corporation cannot pay common shareholders any dividends until it has paid the preferred dividends in arrears.

54. Cumulative Preferred Stock (Slide 2 of 2)
Example Kali Corporation has outstanding 1,000 shares of 10%, $100 par cumulative preferred stock. Each share of stock is entitled to a $10 annual dividend (10% × $100 par value).
If Kali does not pay dividends in 2016 and 2017, preferred shareholders would be entitled to dividends in arrears of:
$10,000 at the end of 2016 (1,000 shares × $10 per share)
$20,000 at the end of 2017 (1,000 shares × $10 per share × 2 years)
At the end of 2018, Kali would have to pay $30,000 (1,000 shares × $10 per share × 3 years) to preferred stockholders before it could pay any dividends to common stockholders.

55. Participating Preferred Stock
Participating preferred stock is stock carrying the provision that preferred shareholders share with the common shareholders in any additional dividends.
Participating preferred stock may be either fully or partially participating.
Fully participating preferred shareholders are shareholders who share equally with the common shareholders in any extra dividends.
Partially participating preferred shareholders are shareholders who share in extra dividends, but the participation is limited to a fixed rate or amount per share.

56. Convertible Preferred Stock (Slide 1 of 2)
Convertible preferred stock is stock with a provision that allows shareholders, at their option and under specified conditions, to convert the shares of preferred stock into another security of the corporation.
Accounting for the conversion of preferred to common stock is very straightforward because the book value method is used.
Example Pender Corporation originally issued 500 shares of $100 par convertible preferred stock at $120 per share.
Each preferred share may be converted into four shares of $20 par common stock and all shares are converted.

57. Convertible Preferred Stock (Slide 2 of 2)
Pender makes the following journal entry at conversion:
Preferred Stock, $100 par 50,000
Additional Paid-in Capital on Preferred Stock 10,000
Common Stock, $20 par (4 × 500 × $20) 40,000
Additional Paid-in Capital from Preferred
Stock Conversion ($60,000 ‒ $40,000) 20,000
If the total contributed capital eliminated for the preferred stock is more than the common stock par value, the corporation records the excess as an increase in additional paid-in capital related to the conversion.
The conversion of preferred to common stock changes the components of shareholders’ equity, but does not affect the corporation’s total shareholders’ equity.

58. Preferred Stock with Stock Warrants (Slide 1 of 3)
A corporation may also attach warrants to preferred stock to enhance their attractiveness.
These warrants represent rights that allow the holder to purchase additional shares of common stock at a specified price over some future period.
Because these warrants are detachable from the preferred stock, they usually begin trading on the stock market at some market price.
The investor in detachable preferred stock has dual rights:
Right to dividends that will be paid on the preferred stock
Right to the market value appreciation of the common stock that may be purchased as a result of the warrants

59. Preferred Stock with Stock Warrants (Slide 2 of 3)
Example Belmont Corporation issues 1,000 shares of $100 par value preferred stock at a price of $120 per share.
It attaches a warrant to each share of stock that allows the holder to purchase one share of $10 par common stock at $40 per share.
Immediately after the issuance, the preferred stock begins selling ex rights (without the rights attached) on the market for $119 per share and the warrants begin selling for $6 each.
Preferred Stock:
$119,000
$119,000 + $6,000
× $120,000 = $114,240
Common Stock Warrants:
$6,000
× $120,000 = , 760
$120,000

60. Preferred Stock with Stock Warrants (Slide 3 of 3)
Belmont makes the following journal entry:
Cash ($121 × 1,000 shares) 120,000
Preferred Stock, $100 par 100,000
Additional Paid-in Capital on Preferred
Stock 14,240
Common Stock Warrants 5,760
Assuming all warrants are exercised. Belmont makes the following journal entry to record the issuance of the 1,000 shares of common stock in exchange for the warrants and $40 per share:
Cash ($40 × 1000 shares) 40,000
Common Stock Warrants 5,760
Common Stock, $10 par 10,000
Additional Paid-in Capital on Common Stock 35,760

61. Callable Preferred Stock
Callable preferred stock is stock that may be retired (recalled) under specified conditions by a corporation at its discretion.
Example Li Corporation has outstanding 1,000 shares of $100 par callable preferred stock that were issued at $110 per share and that have no dividends in arrears.
If the call price is $112 per share, Li makes the following journal entry to record the call of these shares:
Preferred Stock, $100 par 100,000
Additional Paid-in Capital on Preferred Stock 10,000
Retained Earnings ($112,000 ‒ $110,000) 2,000
Cash ($112 × 1,000 shares) 112,000
The debit to Preferred Stock is a permanent reduction to Stockholders’ Equity.

62. Redeemable Preferred Stock
In contrast to convertible preferred stock and callable preferred stock, some preferred stock is redeemable.
Redeemable preferred stock is stock that may either be subject to mandatory redemption at a specified future maturity date for a specified price or redeemable at the option of the holder.
Mandatory redeemable preferred stock is reported as a liability, not equity, because of the obligation of a cash outflow in the future that the company has no ability to prevent.
Preferred stock that is redeemable at the option of the holder is not reported as a liability. It is reported in shareholders’ equity.

63. Preference in Liquidation
If a corporation is liquidated, the preferred stock contract usually allows the preferred shareholders liquidation preference over the common shareholders (but secondary to creditors).
The preference is typically expressed as a percentage of (or equal to) the par value.
It also frequently requires the payment of dividends in arrears.
A corporation discloses this information either parenthetically in its shareholders’ equity section or in the notes accompanying its financial statements.

64. Treasury Stock Learning Objective #7
Treasury stock is a corporation’s own capital stock that (1) has been fully paid for by the shareholders, (2) has been legally issued, (3) reacquired by the corporation, and (4) is being held by the corporation for future issuance.
A corporation may acquire treasury stock to:
Use for share option, bonus, and employee purchase plans
Use in the conversion of convertible preferred stock or bonds
Use excess cash
Use in acquiring other companies
Signal to the capital market that the company managers believe the shares are underpriced

65. What is Treasury Stock and How is it Accounted For? (Slide 2 of 3)
Reduce the number of shares held by hostile shareholders and thereby reduce the likelihood of being acquired by another company
Use for the issuance of a stock dividend
Treasury stock is not an asset.
To ensure that treasury stock is handled in the best interest of the shareholders, states have passed laws regulating corporate activities as follows:
A corporation must acquire treasury stock for some legitimate corporate purpose.
Treasury stock does not vote, has no preemptive rights, ordinarily cannot participate in dividends or liquidation.
Treasury stock does not participate in stock splits.

66. What is Treasury Stock and How is it Accounted For? (Slide 2 of 3)
The acquisition of treasury stock does not formally reduce a corporation’s legal capital.
Treasury stock transactions may reduce retained earnings but may never increase retained earnings.
If the treasury shares are not retired, the corporation may reissue the treasury stock at a price above or below the acquisition price or the par value.
A corporation may account for treasury stock transactions by either the cost method or the par (stated) value method. The cost method is used by the vast majority of companies that hold treasury stock.

67. Cost Method (Slide 1 of 2)
Under the cost method, when the corporation reacquires its capital stock, it assumes it will reissue rather than retire the stock.
Example Ball Corporation is authorized to issue 20,000 shares of $10 par common stock and enters into several treasury stock transactions as follows:

68. Cost Method (Slide 2 of 2)
Note that treasury stock was reissued at less than par.
Note that the retained earnings account is debited for $100.

69. Balance Sheet Presentation

70. Contributed Capital Section Structure Learning Objective #8

71. Real Report: Contributed Capital (Slide 1 of 3)

72. Real Report: Contributed Capital (Slide 2 of 3)
What is the par value of Starbucks’s common stock? How many more shares can Starbucks issue as of September 29, 2013?
The par value of Starbucks’s common stock is $0.001 per share. Starbucks has authorized 1,200 million shares of common stock and has issued and outstanding shares at September 29, 2013 of million, so the company may issue million additional shares.
How many shares of common stock did Starbucks repurchase and retire during the fiscal year ended September 29, 2013? What was the effect of these transactions on shareholders’ equity? What was the average price paid per share acquired during 2010?
Starbucks repurchased and retired 10,800,000 shares of common stock during This reduced Additional Paid-in Capital by $288,500,000. The average price for a share of common stock was $50.52
How many classes of capital stock have been authorized by Starbucks?
Starbucks has authorized both preferred and common; however, the company has not issued any preferred shares.