1. Chapter 11
Stockholders’ Equity

2. Learning Objectives
LO1 Understand the concept of stockholders’ equity and identify the components of the Stockholders’ Equity category. LO2 Show that you understand the characteristics of common and preferred stock and the differences between the classes of stock. LO3 Determine the financial statement impact when stock is issued for cash or for other consideration. LO4 Describe the financial statement impact of stock treated as treasury stock. LO5 Compute the amount of cash dividends when a firm has issued both preferred and common stock.

3. Learning Objectives (continued)
LO6 Show that you understand the difference between cash and stock dividends and the effect of stock dividends. LO7 Determine the difference between stock dividends and stock splits. LO8 Show that you understand the statement of stockholders’ equity and comprehensive income. LO9 Understand how investors use ratios to evaluate stockholders’ equity. LO10 Explain the effects that transactions involving stockholders’ equity have on the statement of cash flows.

4. Learning Objectives (continued)
LO11 Describe the important differences between the sole proprietorship and partnership forms of organization versus the corporate form (Appendix).

5. Module 1 Stockholders’ Equity, Issuance of Stock, and Treasury Stock
There are various components presented in the Stockholders’ Equity section of the balance sheet
There are different types of stock that companies can issue and there are advantages of each class of stock
Treasury stock is important
Module 1

6. Stockholders’ Equity
Owners of a corporation and have a residual interest in assets after liabilities are satisfied
Module 1: LO 1

7. Exhibit 11-1—Advantages and Disadvantages of Stock versus Debt Financing
Module 1: LO 1

8. Stockholders’ Equity on the Balance Sheet
The basic accounting equation:
Assets = Liabilities + Stockholders’ Equity
Two major components or subcategories:
Contributed Capital
Retained Earnings
Total Stockholders’ Equity = Contributed Capital + Retained Earnings
Module 1: LO 1

9. Components of the Stockholders’ Equity Section of the Balance Sheet
Number of Shares
Par Value
Additional Paid-In Capital
Retained Earnings
Module 1: LO 1

10. Exhibit 11-2—Retained Earnings Connects the Income Statement and the Balance Sheet
Module 1: LO 1

11. Contributed Capital Common stock Preferred stock Carries voting rights
The common stockholders elect the corporation’s officers
Establish its bylaws and governing rules
Preferred stock
Flexible and tailored to a company’s needs
Preference in dividends
Module 1: LO 1

12. Number of Shares
Authorized shares: the maximum number of shares a corporation may issue as indicated in the corporate charter
Issued shares: the number of shares sold or distributed to stockholders
Outstanding shares: the number of shares issued less the number of shares held as treasury stock
Module 1: LO 1

13. Par Value
An arbitrary amount that represents the legal capital of the firm
Stated on the face of the stock certificate
Also called “stated value”
Amount presented in the stock account
Module 1: LO 1

14. Additional Paid-In Capital and Retained Earnings
Additional paid-in capital: the amount received for the issuance of stock in excess of the par value of the stock
Retained earnings: net income that has been made by the corporation but not paid out as dividends
Not necessarily available to stockholders
May be used for purchase of assets, the retirement of debt, or other financial needs
Module 1: LO 1

15. IFRS and Stockholders’ Equity
Convertible bond
International accounting rules
Separated into two parts—liability and stockholders’ equity
U.S. accounting standards
Do not require to be recorded as a separate amount
Recorded as either liability or stockholders’ equity
Module 1: LO 1

16. Preferred Stock Flexible and tailored to a company’s needs
Preference to dividends before the common stockholders
Right to the company’s assets before the common stockholders during liquidation
The dividend rate maybe stated in two ways:
Percentage of the stock’s par value
Per-share amount
Module 1: LO 2

17. Preferred Stock Additional Terms and Features
Convertible: allows preferred stock to be exchanged for common stock
Redeemable: allows stockholders to sell stock back to the company
Callable: Allows the firm to eliminate a class of stock by paying the stockholders a specified amount
Module 1: LO 2

18. Preferred Stock Additional Terms and Features (continued)
Cumulative: the right to dividends in arrears before the current-year dividend is distributed
Participating: Allows preferred stockholders to share on a percentage basis in the distribution of an abnormally large dividend
Module 1: LO 2

19. Issuance of Stock Issued for cash or for noncash assets
When issued for cash:
Par value reported in the stock account
Amount in excess of par is reported in the Paid-In Capital account
When exchanged for noncash items:
Recorded at the fair market value of the stock or the assets received, whichever is most readily determined
Module 1: LO 3

20. Example 11-1—Recording Stock Issued for Cash
Assume that on July 1, a firm issued 1,000 shares of $10 par common stock for $15 per share
The transaction is recorded as follows:
Module 1: LO 3

21. Example 11-2—Recording Stock for Noncash Consideration
Assume that on July 1, a firm issued 500 shares of $10 par preferred stock to acquire a building
The building has recently been appraised by an independent firm as having a market value of $12,000
The issuance of the stock should be recorded as follows:
Module 1: LO 3

22. Treasury Stock Issued by the firm and then repurchased but not retired
Repurchase is recorded as a debit to Treasury Stock, a contra-equity account
For an amount to be treated as treasury stock:
It must be the corporation’s own stock
It must have been issued to the stockholders at some point
It must have been repurchased from the stockholders
It must not be retired, but must be held for some purpose
Module 1: LO 4

23. Example 11-3—Recording the Purchase of Treasury Stock
The Stockholders’ Equity section of Rezin Company’s balance sheet on December 31, 2016, appears as follows:
Module 1: LO 4

24. Example 11-3—Recording the Purchase of Treasury Stock (continued)
Assume that on February 1, 2017, Rezin buys 100 of its shares as treasury stock at $25 per share
Rezin records the following transaction at that time:
Module 1: LO 4

25. Example 11-3—Recording the Purchase of Treasury Stock (continued)
The Stockholders’ Equity section of Rezin’s balance sheet on February 1, 2017, after the purchase of the treasury stock
Module 1: LO 4

26. Retirement of Stock Repurchase of stock with no intention of reissuing
To eliminate a particular class of stock or group of stockholders
The general principle for retirement of stock is the same as for treasury stock transactions
No income statement accounts are affected
Effect is reflected in the Cash account and the Stockholders’ Equity accounts
Module 1: LO 4

27. Module 2 Cash Dividends, Stock Dividends, and Stock Splits
A company might pay cash or stock dividends
Module 2

28. Cash Dividends
Declared only if a company has sufficient cash available and adequate retained earnings
Not an expense on the income statement
Date of declaration: cash dividends are declared
Payment date: cash dividends are paid
Date of record: dividend is paid to the stockholders who own the stock as of this date
Module 2: LO 5

29. Dividend Payout Ratio
The annual dividend amount divided by the annual net income
Ratio for many firms is 50% or 60% and seldom exceeds 70%
Module 2: LO 5

30. Example 11-4—Recording the Declaration of a Dividend
Assume that on July 1, the board of directors of Grant Company declared a cash dividend of $7,000 to be paid on September 1
Grant reflects the declaration as a reduction of Retained Earnings and an increase in Cash Dividend Payable as follows:
Module 2: LO 5

31. Stock Dividends
The issuance of additional shares of stock to existing stockholders
Firms use stock dividends for several reasons
Do not require the use of cash
Reduce the market price of the stock
The lower price may make the stock more attractive
Do not represent taxable income to recipients
Module 2: LO 6

32. Example 11-7—Recording a Small Stock Dividend
Assume that Shah Company’s Stockholders’ Equity category of the balance sheet appears as follows as of January 1, 2016:
Module 2: LO 6

33. Example 11-7—Recording a Small Stock Dividend (continued)
Assume that on January 2, 2016, Shah declares a 10% stock dividend to common stockholders to be distributed on April 1, 2016
Assume that Shah’s common stock is selling at $40 per share on that date
Therefore, the total market value of the stock dividend is $20,000 (10% of 5,000 shares outstanding, or 500 shares, times $40 per share)
Shah records the transaction on the date of declaration as follows:
Module 2: LO 6

34. Example 11-7—Recording a Small Stock Dividend (continued)
The Stockholders’ Equity section of Shah’s balance sheet on January 2, 2016, is as follows after the declaration of the dividend:
Module 2: LO 6

35. Example 11-8—Recording the Declaration of a Large Stock Dividend
Assume that instead of a 10% dividend, on January 2, 2016, Shah declares a 100% stock dividend to be distributed on April 1, 2016
The stock dividend results in 5,000 additional shares being issued and certainly meets the definition of a large stock dividend. Shah records the following transaction on January 2, the date of declaration:
Module 2: LO 6

36. Example 11-8—Recording the Declaration of a Large Stock Dividend (continued)
The accounting transaction to be recorded when the stock is actually distributed is as follows:
Module 2: LO 6

37. Example 11-8—Recording the Declaration of a Large Stock Dividend (continued)
The Stockholders’ Equity category of Shah’s balance sheet as of April 1 after the stock dividend is as follows:
Module 2: LO 6

38. Stock Splits
The creation of additional shares of stock with a reduction of the par value of the stock
Stock dividends
Do not affect the par value per share of the stock
Recorded
Stock Splits
Reduce the par value per share
Not recorded
Stockholders’ Equity accounts are not affected
Module 2: LO 7

39. Example 11-9—Reporting a Stock Split
Assume that on January 2, 2016, Shah issued a 2-for-1 stock split instead of a stock dividend
The split results in an additional 5,000 shares of stock outstanding but is not recorded in a formal accounting transaction
Therefore, the Stockholders’ Equity section of Shah Company immediately after the stock split on January 2, 2016, is as follows:
Module 2: LO 7

40. Module 3 Analysis and Cash Flow Issues
Comprehensive income differs from the net income amount a company may present
Stockholders’ equity items affect the cash flow statement
Module 3

41. Statement of Stockholders’ Equity
Reflects the reasons for the difference between the beginning and ending balances for all accounts in the Stockholders’ Equity category of the balance sheet
Module 3: LO 8

42. Exhibit 11-3—Fun Fitness’s Statement of Stockholders’ Equity, 2016
Module 3: LO 8

43. Exhibit 11-3—Fun Fitness’s Statement of Stockholders’ Equity, 2016 (continued)
Module 3: LO 8

44. Comprehensive Income
Total change in net assets from all sources except investments by or distributions to the owners
Important measure of a company’s profitability
One-statement approach
Shown at the bottom of the income statement
Two-statement approach
Statement of Comprehensive Income must be presented
Module 3: LO 8

45. Exhibit 11-4—The Relationship between the Income Statement and the Statement of Comprehensive Income
Module 3: LO 8

46. Book Value Per Share
Book value per share: total stockholders’ equity divided by the number of shares of common stock outstanding
If preferred stock is present, stockholders’ equity must be adjusted to reflect its liquidation value
Module 3: LO 9

47. Calculating Book Value When Preferred Stock Is Present
If preferred stock is present, stockholders’ equity must be adjusted to reflect its liquidation value
Module 3: LO 9

48. Exhibit 11-5—Workout Wonders’ Stockholders’ Equity Section
Module 3: LO 9

49. Exhibit 11-5—Workout Wonders’ Stockholders’ Equity Section (continued)
The company had total stockholders’ equity in 2016 of $13,972 million, but preferred stockholders had a right to $500 million in the event of liquidation
Therefore, $500 million must be deducted to calculate the rights of the common stockholders:
$13,972 – $500 = $13,472 million common stockholders’ equity
The number of shares of common stock outstanding for the company is 1,782 million issued less 103 million of treasury stock
Therefore, the computation of book value per share is as follows:
$13,472/1,679 = $8.02 Book Value per Share
Module 3: LO 9

50. Market Value per Share
The selling price of the stock as indicated by the most recent transactions
For example: the listing for Nike Inc. stock on the Internet may indicate the following:
Module 3: LO 9

51. Exhibit 11-6—The Effect of Stockholders’ Equity Items on the Statement of Cash Flows
Module 3: LO 10

52. Exhibit 11-7—Southwest Airlines Co.’s Partial Statement of Cash Flows
Module 3: LO 10

53. Module 4 Sole Proprietorships and Partnerships (Appendix)
Sole proprietorships and partnerships present their equity accounts differently
Module 4

54. Sole Proprietorships Business owned by one person
The owner has an unlimited liability
Not a separate entity for legal or tax purposes
Assets and liabilities of the owner must be kept separate from the business
Owners’ equity is one account—the owner’s capital account
Module 4: LO 11

55. Example 11-10—Recording Investments in a Sole Proprietorship
Assume that on January 1, 2014, Peter Tom began a new business by investing $10,000 cash
Module 4: LO 11

56. Example 11-10—Recording Investments in a Sole Proprietorship (continued)
Assume that on July 1, 2016, Peter Tom took an auto valued at $6,000 from the business to use as his personal auto. The transaction is recorded as follows:
Module 4: LO 11

57. Example 11-10—Recording Investments in a Sole Proprietorship (continued)
At the end of the fiscal year, the drawing account should be closed to the capital account as follows:
Module 4: LO 11

58. Example 11-10—Recording Investments in a Sole Proprietorship (continued)
The Income Summary account is closed to capital as follows:
Module 4: LO 11

59. Example 11-10—Recording Investments in a Sole Proprietorship (continued)
The Owner’s Equity section of the balance sheet for Peter Tom Company consists of one account, the capital account, calculated as follows:
Module 4: LO 11

60. Partnership
Partnership: A business owned by two or more individuals that has the characteristic of unlimited liability
Module 4: LO 11

61. Characteristics of Partnerships
Unlimited liability
Legally, the assets of the business are not separate from the partners’ personal assets
Each partner is personally liable for the debts of the partnership
Creditors have a legal claim first to the assets of the partnership and then to the assets of the individual partners
Module 4: LO 11

62. Characteristics of Partnerships (continued)
Limited life
Partnerships do not have a separate legal existence and an unlimited life
The life of a partnership exists only so long as the contract between the partners is valid
The partnership ends when a partner withdraws or a new partner is added
A new partnership must be created for the business to continue
Module 4: LO 11

63. Characteristics of Partnerships (continued)
Not taxed as a separate entity
Partnerships are subject to the same tax features as sole proprietorships
The partnership itself does not pay federal income tax
The income of the partnership is treated as personal income on each of the partners’ individual tax returns and is taxed as personal income
Partnership income is subject to federal income tax even if it is not distributed to the partners
Module 4: LO 11

64. Partnership Agreement
Specifies how much the owners will invest, what their salaries will be, and how profits will be shared
Module 4: LO 11

65. Example 11-11—Recording Investments in a Partnership
Assume that on January 1, 2016, Paige Thoms and Amy Rebec begin a partnership named AP Company
Paige contributes $10,000 cash, and Amy contributes equipment valued at $5,000
The accounting transaction recorded by AP Company is as follows:
Module 4: LO 11

66. Example 11-11—Recording Investments in a Partnership (continued)
Assume that on April 1, 2016, each owner withdraws $2,000 of cash from AP Company
The accounting entry is recorded as follows:
Module 4: LO 11

67. Distribution of Income
Assume that AP Company has $30,000 of net income for the period and has established an agreement that income should be allocated evenly between the two partners, Paige and Amy
Each capital account would be increased by $15,000
The accounting entry that AP Company records during the closing entry process is as follows:
Module 4: LO 11

68. Distribution of Income
Another way to allocate income is to specify in the partnership agreement that income be allocated according to a stated ratio
For example, Paige and Amy may specify that all income of AP Company should be allocated in a 2-to-1 ratio, with Paige receiving the larger portion
Module 4: LO 11

69. Distribution of Income
An allocation method that more accurately reflects the partners’ input is based on salaries, interest on invested capital, and a stated ratio
If AP Company calculated that its 2016 net income (before partner salaries) was $30,000, income would be allocated between the partners as follows:
Module 4: LO 11

70. Distribution of Income
The accounting transaction to transfer the income to the capital accounts is as follows:
Module 4: LO 11

71. Review
LO1 Understand the concept of stockholders’ equity and identify the components of the Stockholders’ Equity category.
Stockholders’ equity consists of contributed capital from stockholders and retained earnings from the current and prior periods of operation that have not been paid as dividends.
Disclosure for stocks must include the number of shares authorized, issued, and outstanding, along with the par value.

72. Review
LO2 Show that you understand the characteristics of common and preferred stock and the differences between the classes of stock.
The types of stock issued by a firm are common stock and preferred stock.
Preferred stock receives first preference for dividends and generally provides a more stable dividend stream to stockholders than does common stock.
Common stockholders have a claim to the residual interest in a company after all debtors’ and preferred stockholders’ claims are satisfied. Generally, only common stockholders are allowed voting rights.

73. Review
LO3 Determine the financial statement impact when stock is issued for cash or for other consideration.
When stock is issued for cash or other consideration, the number of outstanding shares is increased and the par value of stock is recorded along with any amount in excess of par being recorded to the Additional Paid-In Capital account.
When stock is sold for cash, the asset Cash is increased. When issued for noncash consideration, other asset accounts are increased.
LO4 Describe the financial statement impact of stock treated as treasury stock.
Treasury stock results when a corporation buys back its own stock.
Treasury stock is accounted for as a contra-equity account and is a reduction of stockholders’ equity.

74. Review
LO5 Compute the amount of cash dividends when a firm has issued both preferred and common stock.
The amount of a preferred stock dividend depends on the terms of the stock agreement: cumulative, noncumulative, or cumulative and participating.
LO6 Show that you understand the difference between cash and stock dividends and the effect of stock dividends.
Stock dividends are given in lieu of cash dividends. Stockholders receive shares of stock, which do not require a current use of cash resources by the corporation.
Stock dividends do not affect total stockholders’ equity. They reduce retained earnings and increase the amount of common stock and additional paid-in capital.

75. Review
LO7 Determine the difference between stock dividends and stock splits.
Both stock splits and stock dividends increase the number of shares of stock outstanding although they are fundamentally different transactions.
Stock splits do not require an accounting transaction to be recorded, do not reduce the par value of the stock, and have no effect on retained earnings or additional paid-in capital.

76. Review
LO8 Show that you understand the statement of stockholders’ equity and comprehensive income.
The statement of stockholders’ equity shows how all of the equity accounts changed for a particular accounting period or specific periods.
Comprehensive income is based on the notion that the income statement be inclusive of all items affecting the wealth of an entity. The calculation of comprehensive income takes into account the increase in net assets during a time period.

77. Review
LO9 Understand how investors use ratios to evaluate stockholders’ equity.
Ratios used to analyze stockholders’ equity are designed to measure some aspect of the value of the firm held by stockholders. Some common measures include:
Book value per share—a measure based on balance sheet accounting amounts recorded.
Market value per share—a measure aimed at assessing fair market value based on the current price of stock.

78. Review
LO10 Explain the effects that transactions involving stockholders’ equity have on the statement of cash flows.
Transactions involving stockholders’ equity accounts are classified as financing activities.
Issuing stock produces cash inflows. Dividends and the retirement or repurchase of stock produce cash outflows.

79. Review
LO11 Describe the important differences between the sole proprietorship and partnership forms of organization versus the corporate form (Appendix).
Sole proprietorships are businesses that are not incorporated and are owned by one individual. The business entity and individual are not distinguished from one another for legal and tax purposes.
Partnerships are also unincorporated entities but are owned by two or more individuals. The partners and their respective shares of the business are not distinguished from one another for legal purposes. The partnership itself is not taxed on earnings, but individual partners are taxed for their share.
Corporations, unlike partnerships, have some of the following distinguishing characteristics: they are generally taxable entities and have an unlimited life. The corporate form has been adopted by most larger businesses and is therefore emphasized in this text.

80. End of Chapter 11