1. Principles of Financial Accounting 2002e
Belverd E. Needles, Jr.
Marian Powers
Susan Crosson
Multimedia Slides by:
Harry Hooper
Santa Fe Community College
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2. Chapter 14 Contributed Capital

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LEARNING OBJECTIVES
Identify and explain the management issues related to contributed capital.
Define start-up and organization costs and state their effects on financial reporting.
Identify the components of stockholders’ equity.
Account for cash dividends.
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4. LEARNING OBJECTIVES (continued)
5. Identify the characteristics of preferred stock, including the effect on distribution of dividends.
6. Account for the issuance of stock for cash and other assets.
7. Account for treasury stock.
8. Account for the exercise of stock options.
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5. Management Issues Related to Contributed Capital
OBJECTIVE 1
Identify and explain the management issues related to contributed capital.

6. Advantages of Financing with Common Stock
Less risky than financing with bonds.
Dividends paid only on decision by board of directors.
If a company does not pay a dividend, it may reinvest the cash.
May need to improve the balance between liabilities and stockholders’ equity.
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7. Disadvantages of Financing with Common Stock
Dividends paid are not tax deductible.
Issuing stock dilutes ownership.
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A Corporation
A legal entity separate and distinct from its owners.
Issues faced by management:
Managing under the corporate form.
Using equity financing.
Determining dividend policies.
Evaluating performance using return on equity.
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Forming a Corporation
The articles of incorporation, when approved, become the company charter, a contract between the state and the incorporator.
Authority to manage a corporation is delegated by the owners, through the board of directors, to the corporate officers.
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10. The Corporate Form of Business
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Stockholders own shares representing a proportionate share of ownership in the corporation. Shares may be transferred at will. Stockholders receive a return on investment from dividends and a rise in market value of the stock.
The Board of Directors, are elected by stockholders and decide major policies.
Dividends are the distribution of resources to the stockholders when the corporation has earned a profit.
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Management is appointed by the Board of Directors to carry out policy and run day-to-day operations. Operating officers generally consist of:
President
Vice Presidents
Controller
Treasurer
Secretary
Management prepares financial reports for stockholders.
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Sources of Capital Raised by Corporations in the United States
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14. Advantages of the Corporate Form of Business
Separate legal entity.
Limited liability.
Ease of capital generation.
Ease of transfer of ownership.
Lack of mutual agency.
Continuous existence.
Centralized authority and responsibility.
Professional management.
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15. Disadvantages of the Corporate Form of Business
Government regulation.
Taxation.
Limited liability.
Separation of ownership and control.
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16. Using Equity Financing
A share of stock is a unit of ownership in a corporation.
A stock certificate is issued to the owner.
Stockholders can transfer their ownership at will.
Independent registrars and transfer agents are often used to keep track of stockholders’ records.
Authorized stock is the maximum number of shares a corporation is allowed to issue.
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17. The Concepts of Par Value and Legal Value
Par value is an arbitrary amount assigned to each share of stock.
Par value constitutes the legal capital of the corporation.
Legal capital is the number of shares issued times the par value.
Legal capital is the minimum amount that can be reported as contributed capital.
Par value usually bears little or no relationship to the market value or book value of shares.
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18. Initial Public Offering (IPO)
The initial issue of capital stock is underwritten by an underwriter for a fee. The underwriter is the intermediary between the corporation and the investing public.
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19. Determining Dividend Policies
A dividend is a distribution of a corporation’s assets to its stockholders.
Stockholders receive assets in proportion to their ownership.
The board of directors has sole authority to declare dividends, but is influenced by senior managers, usually board members.
Factors other than earnings that affect the decision to pay dividends.
Expected volatility of earnings.
Level of dividends affects cash flows.
Investors may prefer companies that re-invest their profits, rather than pay high dividends, if this leads to an increase in share prices, because capital gains pay less tax than dividend income.
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Ratio Analysis
Investors evaluate the amount of dividends with the ratio dividends yield (DY). DY measures the current return to an investor in the form of dividends.
A measure of investors’ confidence in a company’s future is the price/earnings (P/E) ratio.
DY =
Dividends per Share
Market Price per Share
P/E Ratio =
Market Price per Share
Earnings per Share
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21. Evaluating Performance Using Return on Equity (ROE)
ROE is the most important ratio associated with the stockholders’ equity decision because it is a common measure of management’s performance.
Compensation of top executives is often tied to this measure.
ROE also depends on the level of stockholders’ equity, which can be affected by management decisions, such as repurchasing shares (treasury stock).
Purchase of treasury stock can improve ROE, increase earnings per share, and lower the P/E ratio.
ROE =
Net Income
Average Stockholders’ Equity
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Discussion
Q. Identify whether each of the following characteristics is an advantage or a disadvantage of the corporate form of business.
Ease of transfer of ownership.
Taxation.
Separate legal entity.
Lack of mutual agency.
Government regulation.
Continuous existence.
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1. Advantage
2. Disadvantage
3. Advantage
4. Advantage
5. Disadvantage
6. Advantage
KEY
1. Ease of transfer of ownership.
2. Taxation.
3. Separate legal entity.
4. Lack of mutual agency.
5. Government regulation.
6. Continuous existence.
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24. Organization Costs OBJECTIVE 2
Define start-up and organization costs and state their effects on financial reporting.

25. Start-up and Organization Costs
Start-up and organization costs are the costs of forming a corporation.
They include state incorporation fees, attorneys’ and accountants’ fees, printing of stock certificates, etc.
Accountants expense start-up and organization costs as they are incurred.
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Discussion
Q. What are the start-up and organization costs of a corporation?
A. Start-up and organization costs are the costs incurred in forming a corporation. They include incorporation fees, attorneys’ fees, printing costs, and accountants’ fees during the time that the corporation is being started.
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27. Components of Stockholders’ Equity
OBJECTIVE 3
Identify the components of stockholders’ equity.

28. Components of Stockholders’ Equity
In a corporation’s balance sheet, owners’ claims are called stockholders’ equity.
The equity section is divided into two parts.
Contributed Capital.
Investments made by stockholders.
Provides information about the corporation’s stock, such as types; par value; number of shares authorized, issued, and outstanding.
Retained Earnings.
Earnings since inception, less any losses, dividends, or transfers to contributed capital.
Earnings reinvested in the corporation.
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Common Stock
Common stock is the company’s residual equity.
All other creditors and preferred shareholders rank before common shareholders regarding claims to the corporation’s assets.
Common stock is usually the only stock with voting rights.
Issued stock is the shares sold or otherwise transferred to stockholders.
No rights or privileges until issued.
Outstanding stock has been issued and is still in circulation.
Treasury stock has been issued and repurchased.
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Relationship of Authorized, Unissued, Issued, Outstanding, and Treasury Shares
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Discussion
Q. What kind of information does the contributed capital section of stockholders’ equity provide?
A. The contributed capital section provides information about the corporation’s stock: the types of stock; their par value; and the number of shares authorized, issued, and outstanding.
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32. OBJECTIVE 4 Account for cash dividends.

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Dividends
Dividends can be paid at any time decided by the board of directors.
The board usually cannot pay a dividend that exceeds retained earnings.
A liquidating dividend is normally paid when a company is going out of business.
Sufficient cash must be available to pay a dividend.
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34. Accounting for Dividends
Three important dates are associated with dividends.
1. Date of declaration. (Dividends are declared.)
Feb Cash Dividends Declared ,000
Cash Dividends Payable ,000
Declared cash
dividend to common
stockholders
2. Date of record (Ownership is determined.)
Mar No entry required.
3. Date of payment. (Dividend paid to stockholders of record.)
Mar Cash Dividends Payable ,000
Cash ,000
Payment of cash dividends
declared Feb. 21
Dividends Declared account is closed out to Retained Earnings at the end of the period.
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Discussion
Q. Explain the accounting treatment of cash dividends.
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Discussion
(continued…) A.
On the day of declaration, the total amount of the cash dividend is recorded by a debit to Cash Dividends Declared and a credit to Cash Dividends Payable. On the date of payment, a debit is made to Cash Dividends Payable and a credit is made to Cash. At the end of the accounting period, the Cash Dividends Declared account is closed to Retained Earnings with a debit to Retained Earnings and a credit to Cash Dividends Declared.
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37. Accounting for Dividends
(continued…)
Some companies do not pay dividends.
Growth companies may reinvest profits and their investors earn a return from the increase in the market value of their stock.
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38. Preferred Stock OBJECTIVE 5
Identify the characteristics of preferred stock, including the effect on distribution of dividends.

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Preferred Stock
Preferred stock has preference over common stock in one or more areas.
Preference as to dividends.
Preference as to assets of the business in liquidation.
Preferred stock may be:
Convertible
Callable
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40. Preference as to Dividends
Holders of preferred shares receive dividends before common stockholders.
Preferred stockholders are not guaranteed dividends.
Noncumulative preferred stock receives no dividend if none is declared.
Cumulative preferred stock has a fixed dividend that accumulates from year to year and must be paid before common stockholders can be paid.
Dividends not paid in the year they are due are called dividends in arrears (not a liability.)
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41. Preference as to Assets
Preferred stockholders have a right to receive the par value of their stock or a larger stated liquidation value per share before the common stockholders receive any share of the company’s assets.
They may also be entitled to any dividends in arrears.
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42. Other Types of Preferred Stock
Convertible preferred stock.
Can be exchanged for shares of the company’s common stock at a ratio stated in the preferred stock contract.
Callable preferred stock.
The issuing corporation can, at their option, retire or redeem the preferred shares at a price stated in the preferred stock contract.
The call price is usually higher than the par value of the stock.
A corporation may call its preferred stock for several reasons such as a desire to pay lower dividends or because it has enough profits to retire preferred stock.
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Discussion
Q. Why is it necessary to disclose dividends in arrears? After all, they are a legitimate liability.
A. Disclosure serves to alert potential investors in common stock that those dividends must be paid before common stockholders receive any dividends.
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44. Accounting for Stock Issuance
OBJECTIVE 6
Account for the issuance of stock for cash and other assets.

45. Accounting for Stock Issuance
The par value is the amount per share that is entered into the corporation’s capital stock accounts and that makes up the legal capital of the corporation.
Any amount in excess of par value received from the issuance of stock is recorded in the Paid-in Capital in Excess of Par Value account.
No-par stock is capital stock issued with or without a stated value.
Stated value may be assigned by the board of directors.
Without a stated value, all proceeds are recorded in the Capital Stock account.
Without a par value but with a stated value, shares are recorded in the Capital Stock account at the stated value.
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Par Value Stock
Stock Issued at Par Value:
Jan.1 Cash ,000
Common Stock ,000
Issued 10,000 shares
of $10 par value
common stock for
$10 per share
Stock Issued above Par Value:
Jan. 1 Cash ,000
Common Stock ,000
Paid-in Capital in
Excess of Par
Value, Common ,000
Issued 10,000 shares of
$10 par value common
stock for $12 per share
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No-Par Stock
Stock Issued with no Stated Value:
Jan. 1 Cash ,000
Common Stock ,000
Issued 10,000 shares
of no-par common stock
for $15 per share
Stock Issued with a Stated Value:
Common Stock ,000
Paid-in Capital in
Excess of Stated
Value, Common ,000
Issued 10,000 shares of
no-par common stock of
$10 stated value for $15
per share
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48. Issuance of Stock for Noncash Assets
Stock Issued for Assets or Services:
Jan. 1 Start up and 1,500
Organization Costs
Common Stock 1,000
Paid-in Capital in Excess
of Par Value, Common
Issued 100 shares of $10
par value common stock
for attorney’s services
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Discussion
Q. How is the value of stock determined when stock is issued for noncash assets?
A. When stock is issued for noncash assets, the general rule is to record the transaction at the fair market value of the stock. If the fair market value of the stock cannot be determined, then the fair market value of the assets or services received is used to record the transaction.
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50. OBJECTIVE 7 Account for treasury stock.

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Treasury Stock
Treasury stock is capital stock, either common or preferred, that has been issued and later reacquired by the issuing company and has not subsequently been resold or retired.
The company normally gets the stock back by purchasing the shares on the market.
A purchase of treasury stock reduces assets and stockholders’ equity.
A purchase of treasury stock is not a purchase of assets.
Treasury stock has no rights until it is reissued.
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52. Reasons to Buy Treasury Stock
A company may want to purchase its own stock to:
Have stock available to distribute to employees through stock option plans.
Maintain a favorable market for its stock.
Increase earnings per share.
Maintain additional shares available for such activities as purchasing other companies.
Prevent a hostile takeover.
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53. Accounting for Treasury Stock
Purchase of treasury stock.
Recorded at cost.
Sale of treasury stock.
Can be sold at cost, above cost, or below cost.
If sold above cost, excess is credited to Paid-In Capital, Treasury Stock.
If sold below cost, difference is deducted from Paid-In Capital, Treasury Stock, if available, or Retained Earnings if not.
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54. Accounting for Treasury Stock (continued…)
Treasury stock can be retired:
when the company determines that it will not reissue stock it has purchased.
if the cost of TS is less than original contributed capital, credit Paid-In Capital, Retirement of TS.
if the cost of TS is greater than original contributed capital, debit Retained Earnings.
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Discussion
Q. What effect does the purchase of treasury stock have on return on equity?
A. Since treasury stock reduces equity, the return on equity will increase.
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56. Exercising Stock Options
OBJECTIVE 8
Account for the exercise of stock options.

57. Exercising Stock Options
A stock option plan is an agreement to issue stock to employees according to specified terms.
Under some plans, the option to purchase stock applies to all employees equally, and the stock is purchased at a price close to its market value at the time of purchase. Record as per any issue of stock to outsiders.
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In other cases, the stock option plan may give an employee an option to purchase stock in the future at a fixed price.
Usually offered only to management.
May be motivational because the market value of a company’s stock is tied to the company’s performance.
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59. Accounting for Stock Options Offered in the Future at a Fixed Price
On the date the options are granted, the fair value of the options must be estimated and the amount in excess of the exercise price must be:
Recorded as compensation expense over the grant period. Reported in the notes to the financial statements showing the impact on net income and EPS.
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Discussion
Q. What is a stock option plan and why does a company have one?
A. A stock option plan is an agreement to issue stock to employees according to specified terms. Stock option plans are adopted to give employees an interest in the success of the company. Sometimes they are offered to attract individuals to top management positions.
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OK, LET’S REVIEW . . .
Identify and explain the management issues related to contributed capital.
Define start up and organization costs and state their effects on financial reporting.
Identify the components of stockholders’ equity.
Account for cash dividends.
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AND ALSO . . .
Identify the characteristics of preferred stock, including the effect on distribution of dividends.
Account for the issuance of stock for cash and other assets.
Account for treasury stock.
Account for the exercise of stock options.
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