1. Financial Accounting: Tools for Business Decision Making
Kimmel, Weygandt, Kieso
ELS 1

2. Chapter 11 ` 2

3. Chapter 11 Reporting and Analyzing Stockholders’ Equity
PowerPoint Slides
After studying Chapter 11, you should be able to:
Identify and discuss the major characteristics of a corporation.
Record the issuance of common stock.
Explain the accounting for purchase of treasury stock.
Differentiate preferred stock from common stock.
Prepare the entries for cash dividends and stock dividends.
Identify the items that affect retained earnings.
Prepare a comprehensive stockholders' equity section.
Evaluate a corporation's dividend and earnings performance from a stockholder's perspective. 3 1 3

4. Corporation Possess legal entity Created by law
PowerPoint Slides
Corporation
Possess legal entity
Created by law
Has most of the rights and privileges of a person
Classified by purpose and ownership
Purpose - profit or nonprofit
Ownership - publicly or privately held 4 3 4

5. Publicly Held Corporation
May have thousands of stockholders and its stock is regularly traded on national securities markets 5 5

6. Privately Held Corporation
May have few stockholders and does not offer its stock for sale to general public 6 6

7. Characteristics of a Corporation
Separate legal existence
Limited liability of stockholders
Transferable ownership rights
Ability to acquire capital
Continuous life
Corporation management
Government regulations
Additional taxes 7 7

8. Separate Legal Existence
PowerPoint Slides
Separate Legal Existence
Separate and distinct from owners
Acts under its own name - not name of stockholders
May buy, own, and sell property; borrow money; enter into legally binding contracts; may sue or be sued; pays its own taxes
Owners (stockholders) cannot bind corporation unless owners are agents of the corporation 8 7 8

9. Limited Liability of Stockholders
PowerPoint Slides
Limited Liability of Stockholders
Creditors have recourse only to corporate assets to satisfy claims.
Liability of stockholders limited to investment in corporation.
Creditors have no legal claim on personal assets of owners unless fraud has occurred. 9 8 9

10. Transferable Ownership Rights
PowerPoint Slides
Transferable Ownership Rights
Ownership evidenced by shares of stock.
Transfer of ownership among stockholders has no effect on corporation’s operating activities or assets, liabilities and total stockholders' equity.
Corporation does not participate in transfer of ownership rights after original sale. 10 9 10

11. Ability to Acquire Capital
PowerPoint Slides
Ability to Acquire Capital
Limited liability of stockholders coupled with transferable ownership rights make it easy to raise capital 11 10 11

12. PowerPoint Slides
Continuous Life
Life of corporation stated in charter - may be perpetual or limited to specific number of years (can be extended)
Corporation is separate legal entity, thus life not affected by withdrawal, death, or incapacity of stockholder 12 11 12

13. Corporation Management
PowerPoint Slides
Corporation Management
Stockholders manage corporation indirectly through board of directors.
Board of directors
formulates operating policies
selects officers to execute policy and to perform daily management functions 13 12 13

14. Corporate Organization Chart
PowerPoint Slides
Page 490 in Book
Corporate Organization Chart 14 2

15. PowerPoint Slides
Page 491in Book 15 2

16. Additional Taxes Corporations pay federal and state income taxes.
PowerPoint Slides
Additional Taxes
Corporations pay federal and state income taxes.
Stockholders pay taxes on cash dividends. Corporate income is taxed twice - at the corporate level and at the individual level.
With proprietorships and partnerships, the owner's share of earnings is reported on his personal income tax return. 16 14 16

17. Forming a Corporation States grant corporate charters.
PowerPoint Slides
Forming a Corporation
States grant corporate charters.
Although a corporation may have operating divisions in a number of states, it will be incorporated in only one state.
Some states have laws favorable to the corporate form of business organization. 17 15 17

18. PowerPoint Slides
Forming a Corporation
The corporation establishes by-laws for conducting its affairs upon receipt of its charter from the state of incorporation.
A corporation must obtain a license - subjecting the corporation's operating activities to the general corporation laws of the state - from each state in which it does business. 18 16 18

19. PowerPoint Slides
Page 492 in Book 19 2

20. Stockholder Rights Once it is chartered, the corporation sells stock.
PowerPoint Slides
Stockholder Rights
Once it is chartered, the corporation sells stock.
When a corporation has only one class of stock it is common stock.
Ownership rights are specified in the articles of incorporation or in the by-laws.
Proof of stock ownership is evidenced by a printed or engraved form known as a stock certificate. 20 17 20

21. Stock Certificate Shows...
PowerPoint Slides
Stock Certificate Shows...
name of the corporation
stockholder's name
class and special features of the stock
the number of shares owned
the signatures of duly authorized corporate officials 21 18 21

22. Questions in Issuing Stock
PowerPoint Slides
Questions in Issuing Stock
How many shares should be authorized for sale?
How should the stock be issued?
At what price should the shares be issued?
What value should be assigned to the stock? 22 19 22

23. PowerPoint Slides
Authorized Stock
The amount of stock a corporation is authorized to sell as indicated in the corporate charter.
Disclose the number of shares authorized in the stockholders' equity section of the balance sheet. 23 20 23

24. Corporations Can Issue Stock
PowerPoint Slides
Corporations Can Issue Stock
Directly to investors (typical in closely held corporations)
Indirectly through an investment banking firm (customary with publicly held corporations) 24 22 24

25. Factors Involved in Setting Price of Stock
PowerPoint Slides
Factors Involved in Setting Price of Stock
Company's anticipated future earnings
Its expected dividend rate per share
Its current financial position
Current state of the economy
Current state of the securities market 25 24 25

26. PowerPoint Slides
Par Value Stock
Is capital stock that has been assigned an arbitrary value per share in the corporate charter.
Par value is usually low because some states levy a tax on the corporation based on par value. 26 25 26

27. PowerPoint Slides
Par Value
Represents the legal capital per share that must be retained in the business.
Is the amount that is not available for withdrawal by stockholders. 27 26 27

28. PowerPoint Slides
Legal Capital
Is the amount per share of stock that must be retained in the business for the protection of corporate creditors. 28 26 28

29. PowerPoint Slides
No-Par Value Stock
Is capital stock that has not been assigned a value per share in the corporate charter.
May have a stated value assigned to it by board of directors, which then becomes the legal capital per share. 29 27 29

30. Stated Value of No-Par Stock
PowerPoint Slides
Stated Value of No-Par Stock
Is the amount per share assigned by the board of directors to no-par stock.
Does not indicate or correspond to the market value of the stock. 30 28 30

31. Relationship of Par and No-Par Value to Legal Capital
PowerPoint Slides
Relationship of Par and No-Par Value to Legal Capital 31 31 29

32. Stockholders’ Equity Section of a Corporation’s Balance Sheet...
PowerPoint Slides
Stockholders’ Equity Section of a Corporation’s Balance Sheet...
Two Parts:
Paid-in (contributed) capital
Retained earnings (earned capital)
The distinction between paid-in capital and retained earnings is important from a legal and an economic point of view. 32 30 32

33. PowerPoint Slides
Paid-in Capital
Is the amount paid in to the corporation by stockholders in exchange for shares of ownership. 33 31 33

34. PowerPoint Slides
Retained Earnings
Is earned capital held for future use in the business. 34 31 34

35. Accounting for Common Stock Issues
PowerPoint Slides
Accounting for Common Stock Issues
The issue of common stock affects only paid-in capital accounts.
When the issuance of common stock for cash is recorded, the par value of the shares is credited to Common Stock.
The portion of the proceeds above or below par value is recorded in a separate paid-in capital account. 35 33 35

36. Issuing Stock at Par
PowerPoint Slides
Assume Hydro-Slide, Inc., issues 1,000 shares of $1 par value of common stock at par for cash.
Cash 1, Common Stock 1,000 36 34 36

37. Issuing Stock Above Par
PowerPoint Slides
Issuing Stock Above Par
If Hydro-Slide, Inc., issues an additional 1,000 shares of the $1 par value common stock for cash at $5 per share, the entry is:
Cash 5,000 Common Stock 1,000
Paid-in Capital in 4,000
Excess of Par Value 37 37 35

38. Hydro-Slide, Inc. Partial Balance Sheet
PowerPoint Slides
Page 496 in Book
Stockholders' equity
Paid-in capital
Common stock $ 2,000
Paid-in capital in excess of par ,000
Total paid-in capital $ 6,000
Retained earnings ,000
Total stockholders' equity $33,000 36 38

39. Treasury Stock Is a corporation's own stock that has been issued
PowerPoint Slides
Treasury Stock
Is a corporation's own stock
that has been issued
fully paid for
reacquired by the corporation
held in its treasury for future use 39 38 39

40. Corporations Acquire Treasury Stock to...
PowerPoint Slides
Reissue the shares to officers and employees under bonus and stock compensation plans.
Increase trading of the company's stock in the securities market in the hopes of enhancing its market value.
Have additional shares available for use in the acquisition of other companies.
Reduce the number of shares outstanding and thereby increase earnings per share.
Prevent a hostile takeover. 40 39 40

41. Mead, Inc. Partial Balance Sheet
PowerPoint Slides
Page 498 in Book
Stockholders' equity
Paid-in capital
Common stock,$5par value,
100,000 shares issued and
96,000 outstanding $ 500,000
Retained Earnings ,000
Total stockholders’ equity $ 700,000 36 41

42. Purchase of Treasury Stock
PowerPoint Slides
Purchase of Treasury Stock
On February 1, 1998, Mead acquires 4,000 shares of its stock at $8 per share.
Treasury Stock 32,000
Cash ,000 42 43 42

43. PowerPoint Slides
Treasury Stock
The Treasury Stock account would increase by the cost of the shares purchased - $32,000.
The original paid-in capital account, Common Stock, would not be affected because the number of issued shares does not change.
Treasury stock is deducted from total paid-in capital and retained earnings in the stockholders' equity section of the balance sheet. 43 44 43

44. Mead, Inc. Partial Balance Sheet
PowerPoint Slides
Page 499 in Book
Stockholders' equity
Paid-in capital
Common stock,$5par value,
100,000 shares issued and
96,000 outstanding $ 500,000
Retained Earnings ,000
Total stockholders’ equity ,000
Less: Treasury Stock ,000
Total stockholders’ equity $ 668,000 36 44

45. PowerPoint Slides
Outstanding Stock
The number of shares of issued stock that are being held by stockholders. 45 46 45

46. Preferred stockholders do not have voting rights.
PowerPoint Slides
Preferred Stock
Is capital stock that has contractual preferences over common stock in certain areas.
Preferred Stock may have priority to:
Dividends
Assets in the event of liquidation
Preferred stockholders do not have voting rights. 46 47 46

47. PowerPoint Slides
Preferred Stock
Assume Stine Corporation issues 10,000 shares of $10 par value preferred stock for $12 cash per share.
Cash ,000
Preferred Stock ,000
Paid-in Capital in Excess ,000
of Par Value - Preferred Stock
(Preferred stock may have either a par value or no-par value.) 47 49 47

48. PowerPoint Slides
Dividend Preferences
Preferred stockholders have the right to share in the distribution of corporate income before common stockholders.
If the dividend rate of preferred stock is $5 per share, common shareholders will not receive any dividends in the current year until preferred stockholders have received $5 per share.
The first claim to dividends does not guarantee dividends. 48 50 48

49. PowerPoint Slides
Cumulative Dividend
A feature of preferred stock entitling the stockholder to receive current and unpaid prior-year dividends before common stockholders receive any dividends 49 52 49

50. PowerPoint Slides
Dividends in Arrears
Are preferred dividends that were scheduled to be declared but were not declared during a given period. 50 52 50

51. PowerPoint Slides
Dividends in Arrears
Scientific-Leasing has 5,000 shares of 7%, $100 par value cumulative preferred stock outstanding.
The annual dividend is $35,000 (5,000 x $7 per share).
Dividends are 2 years in arrears.
Dividends in arrears ($35,000 x 2 years) $ 70,000 Current-year dividends ,000 Total preferred dividends $ 105,000 51 51 53

52. PowerPoint Slides
Dividends in Arrears
Not a liability because no obligation exists until a dividend is declared by the board of directors
Must be disclosed in the notes to the financial statements 52 52 54

53. Liquidation Preference
PowerPoint Slides
Liquidation Preference
Is a feature that gives preferred stockholders preference to corporate assets in the event of liquidation. 53 55 53

54. PowerPoint Slides
Dividend
A distribution by a corporation to its stockholders on a pro rata basis
Pro rata means that if you own 10% of the common shares, you will receive 10% of the dividend.
Dividend forms:
cash
property
script (promissory note to pay cash)
stock 54 56 54

55. Cash Dividend A pro rata distribution of cash to stockholders. 55
PowerPoint Slides
Cash Dividend
A pro rata distribution of cash to stockholders. 55 57 55

56. PowerPoint Slides
Cash Dividend
For a corporation to pay a cash dividend, it must have the following:
Retained earnings
Adequate cash
Declared dividends 56 56 58

57. PowerPoint Slides
Cash Dividend
In many states, payment of dividends from legal capital is illegal.
Payment of dividends from paid-in capital in excess of par is legal in some states.
Payment of dividends from retained earnings is legal in all states.
Companies are frequently constrained by agreements with lenders to pay dividends only from retained earnings. 57 57 59

58. Entries for Cash Dividends
PowerPoint Slides
Entries for Cash Dividends
Three dates are important in connection with dividends:
the declaration date
the record date
the payment date 58 61 58

59. PowerPoint Slides
The Declaration Date
The date the board of directors formally declares the cash dividend and announces it to stockholders
Commits the corporation to a binding legal obligation that cannot be rescinded
An entry is required to recognize the decrease in retained earnings and the increase in the liability - Dividends Payable 59 62 59

60. PowerPoint Slides
The Declaration Date
On December 1, 1998, 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 $50,000 (100,000 x $0.50).
12/1 Retained Earnings ,000
Dividends Payable ,000 60 63 60

61. PowerPoint Slides
The Record Date
The date when ownership of the outstanding shares is determined for dividend purposes.
No Entry Necessary 61 64 61

62. PowerPoint Slides
The Payment Date
The date dividend checks are mailed to the stockholders.
January 20 is the payment date for Media General.
Dividends Payable ,000
Cash ,000 62 65 62

63. PowerPoint Slides
Stock Dividends
A pro rata distribution of the corporation's own stock to stockholders
Paid in stock
Results in a decrease in retained earnings and an increase in paid-in capital
Does not decrease total stockholders' equity or total assets
Often issued by companies that do not have adequate cash to issue a cash dividend. 63 66 63

64. PowerPoint Slides
Stock Dividends
You have a 2% ownership interest in Cetus, Inc., owning 20 of its 1,000 shares of common stock.
In a 10% stock dividend, 100 shares (1,000 x 10%) of stock would be issued. You would receive two shares (2% x 100), but your ownership interest would remain at 2% (22/ 1,100).
You now own more shares of stock, but your ownership interest has not changed. 64 67 64

65. Reasons for Stock Dividends
PowerPoint Slides
Reasons for Stock Dividends
To satisfy stockholders' dividend expectations without spending cash
To increase the marketability of its stock by increasing the number of shares outstanding and thereby decreasing the market price per share
To emphasize that a portion of stockholders' equity has been permanently reinvested in the business and, therefore, is unavailable for cash dividends 65 68 65

66. PowerPoint Slides
Stock Dividends
A small stock dividend (less than 20% -25% of the corporation's issued stock) is recorded at the fair market value per share.
A large stock dividend (greater than 20% - 25% of the corporation's issued stock) is recorded at par or stated value per share. 66 69 66

67. PowerPoint Slides
Stock Dividends
Medland Corporation has $300,000 in retained earnings and declares a 10% stock dividend on its 50,000 shares of $10 par value common stock.
The current fair market value of the stock is $15 per share.
The number of shares to be issued is 5,000 (50,000 x 10%).
Retained Earnings will be decreased by $75,000 (5,000 x $15). 67 70 67

68. PowerPoint Slides
Stock Dividends
Retained Earnings ,000
Common Stock Dividends ,000 Distributable
Paid-in Capital in Excess 25,000
of Par Value
The Common Stock Dividends Distributable is an equity account; not a liability account - because assets will not be used to pay the dividend. 68 68 71

69. PowerPoint Slides
Stock Split
The issuance of additional shares of stock to stockholders accompanied by a reduction in the par or stated value. 69 75 69

70. PowerPoint Slides
Stock Split
In a stock split, the number shares is increased in the same proportion that the par or stated value per share is decreased.
A stock split does not have any effect on total paid-in capital, retained earnings, and total stockholders' equity.
With a stock split the number of shares increases. 70 70 76

71. PowerPoint Slides
Stock Split
Because a stock split does not affect the balances in stockholders' equity accounts, it is not necessary to journalize a stock split. 71 71 78

72. Retained Earnings Net income that is retained in the business
PowerPoint Slides
Retained Earnings
Net income that is retained in the business
The balance in retained earnings is part of the stockholders' claim on the total assets of the corporation.
Retained earnings does not represent a claim on any specific asset. 72 79 72

73. PowerPoint Slides
Deficit
A debit balance in retained earnings and reported as a deduction in the stockholders' equity section of the balance sheet 73 81 73

74. Retained Earnings Restrictions
PowerPoint Slides
Retained Earnings Restrictions
Legal, contractual, or voluntary circumstances that make a portion of retained earnings currently unavailable for dividends 74 83 74

75. Partial Balance Sheet (in millions)
PowerPoint Slides
KNIGHT-RIDDER, INC.
Partial Balance Sheet
(in millions)
Page 510 in Book
Stockholders' equity
Common stock, $.02 1/2 par value;
shares authorized ,000,000;
shares issued-- 93,340, $ 1, Additional paid-in capital ,320
Retained earnings ,243
Total stockholders' equity $1,131,508 75 75 88

76. TOTAL CASH DIVIDENDS PAID ON COMMON STOCK
PowerPoint Slides
The Payout Ratio =
TOTAL CASH DIVIDENDS PAID ON COMMON STOCK
NET INCOME
Measures the percentage of earnings distributed in the form of cash dividends to common stockholders 76 90 76

77. DIVIDENDS PAID PER SHARE STOCK PRICE AT END OF YEAR
PowerPoint Slides
The Dividend Yield =
DIVIDENDS PAID PER SHARE
STOCK PRICE AT END OF YEAR
Reports the rate of return an investor earned from dividends. 77 91 77

78. PowerPoint Slides
Earnings Per Share =
NET INCOME - PREFERRED STOCK DIVIDENDS
AVERAGE COMMON SHARES OUTSTANDING
Measures the net income earned on each share of common stock. 78 92 78

79. Price-Earnings Ratio =
PowerPoint Slides
Price-Earnings Ratio =
MARKET PRICE PER SHARE OF STOCK
EARNINGS PER SHARE
In order to make a meaningful comparison of earnings across firms, use the price-earnings ratio.
The price-earnings ratio reflects the investors' assessment of a company's future earnings. 79 93 79

80. Return on Common Stockholders’ Equity Ratio =
PowerPoint Slides
Return on Common Stockholders’ Equity Ratio =
NET INCOME -PREFERRED STOCK DIVIDENDS
AVERAGE COMMON STOCKHOLDERS’ EQUITY
Measures the profitability from the stockholders’ point of view. 80 93 80

81. 81 81