1. © 2015 Cengage Learning. All Rights Reserved.
LESSON
10-2
Accounting for
Preferred Stock
Learning Objectives
LO5 Record the issuance of preferred stock.
LO6 Explain how to account for convertible preferred stock.
© 2015 Cengage Learning. All Rights Reserved.

2. Issuing Preferred Stock
Lesson 10-2
Issuing Preferred Stock
LO5
A corporation owned by a small number of individuals is called a privately held corporation.
The initial issue of a security on a public exchange is called an initial public offering or IPO.
A corporation having its stock traded on public exchanges is called a publicly held corporation.
The document submitted to the SEC for permission to sell a security on a public exchange is called a registration statement.
© 2015 Cengage Learning. All Rights Reserved.

3. Issuing Preferred Stock at Par Value
Lesson 10-2
Issuing Preferred Stock at Par Value
LO5
November 2. Received cash from Zach Ruston for 300 shares of 6%, $ par-value preferred stock at par value, $30, Receipt No. 235.
© 2015 Cengage Learning. All Rights Reserved.

4. Issuing Preferred Stock for More Than Par Value
Lesson 10-2
Issuing Preferred Stock for More Than Par Value
LO5
November 23. Received cash from Sophia Sanchez for 200 shares of 6%, $ par-value preferred stock at $ per share, $20, Receipt No. 489.
© 2015 Cengage Learning. All Rights Reserved.

5. Issuing Stock for Assets Other than Cash
Lesson 10-2
Issuing Stock for Assets Other than Cash
LO5
December 16. Received inventory and store equipment from BSF Supply at agreed values of $45, for inventory and $15, for store equipment. Forest Equipment issued 600 shares of 6%, $ par-value preferred stock.
Memorandum No. 53.
© 2015 Cengage Learning. All Rights Reserved.

6. Convertible Preferred Stock
Lesson 10-2
Convertible Preferred Stock
LO6
Preferred stock that can be exchanged for a specified number of common shares is called convertible preferred stock.
Assume the following example: Five years ago, Chandler Corporation issued 1,000 shares of $ par-value, 4.5% preferred stock. The preferred stock has a conversion option, allowing the stockholder to convert each preferred share into five shares of common stock. If 50 shares were converted:
The ability of a security to be traded for a specified number of shares of another security is called a conversion option.
Par Value ÷ Conversion Ratio = Conversion Price
$100 ÷ = $20
The number of common shares received when a security is converted is called the conversion ratio.
The par or stated value of the preferred stock divided by the conversion ratio is called the conversion price.
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7. Lesson 10-2 Audit Your Understanding
1. To finance rapid expansion, how can a corporation acquire additional capital?
ANSWER
By selling stock to investors or borrowing money.
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8. Lesson 10-2 Audit Your Understanding
2. Must all corporations file their financial statements with the SEC?
ANSWER
No. Only publicly held corporations are required to file their financial statements with the Securities and Exchange Commission.
© 2015 Cengage Learning. All Rights Reserved.

9. Lesson 10-2 Audit Your Understanding
3. How can a business issue stock without causing the voting rights of current common stockholders to be diminished?
ANSWER
By issuing preferred stock that does not offer voting rights.
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10. Lesson 10-2 Audit Your Understanding
4. What is the relationship between an investor’s desired dividend rate and the price at which a preferred stock is issued?
ANSWER
An investor willing to accept a dividend rate lower than that offered by the preferred stock will pay more than the par value. An investor demanding a dividend rate higher than that offered by the preferred stock will pay less than the par value.
© 2015 Cengage Learning. All Rights Reserved.

11. Lesson 10-2 Audit Your Understanding
5. Why does a conversion option add value to preferred stock?
ANSWER
The conversion option enables the corporation to issue the stock with a lower dividend rate. Convertible preferred stock gives the stockholder the ability to share in the income of the corporation through an increase in the market price of the common stock.
© 2015 Cengage Learning. All Rights Reserved.

12. Lesson 10-2 Audit Your Understanding
6. A 6%, $ par-value preferred stock has a conversion ratio of 10. The corporation’s common stock is currently valued at $ Should preferred stockholders convert their stock?
ANSWER
Stockholders should convert their stock if they
believe the market price of the common stock will increase by more than 6% per year, less the effect of any dividends paid on common stock.
© 2015 Cengage Learning. All Rights Reserved.