1. STOCKHOLDERS’ EQUITY: Paid-In Capital
Chapter 11
STOCKHOLDERS’ EQUITY: Paid-In Capital
Chapter 11: Stockholders’ equity: Paid-in capital. 2

2. Corporations An entity created by law. Privately, or Closely, Held
Existence is separate from owners.
Ownership can be
Corporations are entities created by law that exist separately from their owners and have rights and privileges. Ownership in a corporation can be publicly or privately held.
Has rights and privileges.
Publicly Held

3. Learning Objective
To discuss the advantages and disadvantages of organizing a business as a corporation.
Learning objective number 1 is to discuss the advantages and disadvantages of organizing a business as a corporation.
LO1

4. Advantages of Incorporation
Limited personal liability for stockholders
Transferability of ownership
Professional management
The corporate form of organization has several advantages. Corporations are separate legal entities that can enter into contracts, sue, and be sued. Stockholders’ losses are limited to the amount invested in the corporation. Ownership rights are transferable. Most corporations have a professional management team that runs the business on a day-to-day basis. The corporation continues to exist even when ownership changes.
Continuity of existence

5. Disadvantages of Incorporation
Heavy taxation
Greater regulation
Cost of formation
There are also several disadvantages of incorporation. There are extra governmental regulations imposed on corporations and corporate taxation of earnings. Corporations pay taxes on their earnings and if they distribute a dividend to stockholders, the stockholders pay taxes on the dividends received. This is sometimes referred to as double taxation. It’s also costly to form a corporation. And, the separation of stockholder owners from management can create problems as well if management does not act in the best interest of the owners, but rather in the best interest of the management team.
Separation of ownership and management

6. To distinguish between publicly owned and closely held corporations.
Learning Objective
To distinguish between publicly owned and closely held corporations.
Learning objective number 2 is to distinguish between publicly owned and closely held corporations.
LO2

7. Publicly Owned Corporations Face Different Rules
By LAW, publicly owned corporations must:
Prepare financial statements in accordance with GAAP.
Have their financial statement audited by an independent CPA.
Comply with federal securities laws.
Submit financial information for SEC review.
By law, publicly owned corporations must prepare financial statements in accordance with GAAP, have their financial statements audited by an independent certified public accountant, comply with federal securities laws, and submit financial information to the Securities and Exchange Commission for review.

8. Formation of a Corporation
The costs associated with incorporation are usually expensed immediately, but amortized over 5 years for tax purposes.
Each corporation is formed according to the laws of the state where it is located.
The application for corporate status is called the Articles of Incorporation.
Part I
The requirements for forming a corporation are determined by the laws of the state where the corporation is incorporated. The Articles of Incorporation is the application for corporate status.
Part II
The costs incurred to incorporate a business are expensed immediately for financial reporting purposes. However, these costs are amortized over 5 years for tax purposes.

9. Learning Objective
To explain the rights of stockholders and the roles of corporate directors and officers.
Learning objective number 3 is to explain the rights of stockholders and the roles of corporate directors and officers.
LO3

10. Rights of Stockholders
Voting (in person or by proxy).
Proportionate distribution of dividends.
Proportionate distribution of assets in a liquidation.
Rights
Stockholders have several rights. They have a right to vote at stockholders’ meetings; they can sell and buy shares of stock; they receive dividends declared by the Board of Directors; and in the event of liquidation, they share equally in any remaining assets after creditors are paid.
Stockholders

11. Rights of Stockholders
Stockholders usually meet once a year.
Ultimate control
At their annual meeting, stockholders elect the Board of Directors and vote on important management issues facing the company.

12. Rights of Stockholders
Stockholder ledgers are often maintained by a stock transfer agent or stock registrar.
Stockholders usually meet once a year.
Ultimate control
To keep track of the actual owners of a corporation, a stockholder ledger is often maintained by a stock transfer agent or stock registrar. This ledger keeps track of contact information of current stockholders who own the corporation.

13. Rights of Stockholders
Each unit of ownership is called a share of stock.
Stock certificates serve as proof that a stockholder has purchased shares.
This is an example of a stock certificate. This certificate provides proof of ownership in a corporation.

14. Rights of Stockholders
When the stock is sold, the stockholder signs a transfer endorsement on the back of the stock certificate.
When stock is sold, the seller signs a transfer endorsement on the back of the stock certificate.

15. Functions of the Board of Directors
Overall responsibility for managing the company.
Selected by a vote of the stockholders
Once the stockholders elect the Board of Directors, the Board has the ultimate responsibility for managing the company. The Board also hires the executive management team for the corporation.

16. Functions of the Corporate Officers
Contractual and legal representation
Chief Accountant
Custodian of funds
The executive management team manages the day-to-day decisions for the corporation.

17. Learning Objective
To account for paid-in capital and prepare the equity section of a corporate balance sheet.
Learning objective number 4 is to account for paid-in capital and prepare the equity section of a corporate balance sheet.
LO4

18. Stockholders’ Equity of a Corporation
Stockholders’ equity can be increased in two ways. First, equity is increased by issuing stock to investors. This is an increase in Paid-in Capital. Second, equity is increased by the retention of profits earned by the corporation. This is an increase in Retained Earnings.

19. Authorization and Issuance of Capital Stock
Authorized
Shares
The maximum number of shares of capital stock that can be sold to the public.
There are several terms related to stock that must be understood. Authorized shares is the maximum number of shares of stock that can be sold to the public. The number of authorized shares is identified in the corporation’s corporate charter, issued by the state.

20. Authorization and Issuance of Capital Stock
Authorized
Shares
Issued shares are authorized shares of stock that have been sold.
Unissued shares are authorized shares of stock that never have been sold.
Usually shares are sold through an underwriter.
Authorized shares can be classified as issued and unissued. Unissued shares are shares of stock that have never been sold to the public. Issued shares are shares of stock that have been sold to the public at some point.

21. Authorization and Issuance of Capital Stock
Authorized
Shares
Outstanding shares are issued shares that are owned by stockholders.
Outstanding
Shares
Unissued
Shares
Issued
Shares
Part I
Issued shares can be classified as outstanding shares and treasury shares. Outstanding shares are shares that are currently owned by stockholders.
Part II
Treasury shares are shares that once were owned by stockholders but were repurchased by the corporation in the stock market. Thus, the corporation is now the owner of those shares.
Treasury shares are issued shares that have been reacquired by the corporation.
Treasury
Shares

22. Stockholders’ Equity
Par value is an arbitrary amount assigned to each share of stock when it is authorized.
Market price is the amount that each share of stock will sell for in the market.
Par value is an arbitrary amount assigned to each share of stock in the company’s charter. Par value is typically a nominal amount. It is not related in any manner to market value, which is the selling price of a share of stock.

23. Stockholders’ Equity Common stock can be issued in three forms:
Par Value Common Stock
No-Par Common Stock
Stated Value Common Stock
Part I
Stock can have a par value, not have a par value, or have a stated value.
Part II
Let’s look at how to account for par value stock. Accounting entries for stated value stock are very similar to accounting for par value stock. When a company has no-par stock, all the proceeds are credited to the Common Stock account.
Let’s examine this form of stock.
All proceeds credited to Common Stock
Treated like par value common stock

24. Issuance of Par Value Stock
Record:
The cash received.
The number of shares issued × the par value per share in the Common Stock account.
The remainder is assigned to Contributed Capital in Excess of Par.
When par value stock is sold for cash, the Common Stock account is credited for the par value of the stock sold. Remember that par value and market value are not related. The difference between the par value of the stock and the market value of the stock is credited to Contributed Capital in Excess of Par. If the amount of par value in the Common Stock account and the amount in the Contributed Capital in Excess of Par were added together, the result would be the market value of the sale of the stock.
Let’s record the entry for the issue of 10,000 shares of $2 par value common stock for $25 per share.
Matrix, Inc. issues 10,000 shares of its $2 par value stock for $25 per share on September 1, 2007.

25. Issuance of Par Value Stock
Matrix, Inc. issues 10,000 shares of its $2 par value stock for $25 per share on September 1, 2007.
To record this stock issue, debit Cash for the market value of the stock sold: 10,000 shares times $25 per share. Credit Common Stock for the par value of the share sold: 10,000 shares times $2 per share. Finally, credit Contributed Capital in Excess of Par Value for the excess of market over par: 10,000 times $23 per share.
10,000 × $2 = $20,000

26. Issuance of Par Value Stock
This slide shows how to report the stock on the balance sheet. The $20,000 is the par value of the stock sold and the $230,000 is the excess over par value for the stock. These two accounts total $250,000 and equal the amount of cash received for the sale of the stock.

27. Learning Objective
To contrast the features of common stock with those of preferred stock.
Learning objective number 5 is to contrast the features of common stock with those of preferred stock.
LO5

28. Preferred Stock Other Features Include:
A separate class of stock, typically having priority over common shares in . . .
Dividend distributions (rate is usually stated).
Distribution of assets in case of liquidation.
Other Features Include:
Preferred stock is a separate class of stock that typically has priority over common stock in dividend distributions and distribution of assets in a liquidation.
Preferred stock usually has a stated dividend that is expressed as a percentage of its par value. It normally does not have voting rights and is often callable by the corporation at a stated value.
Let’s take a closer look at the cumulative dividend rights of preferred stock on the next screen.
Cumulative dividend rights.
Usually callable by the company.
Normally has no voting rights.

29. Cumulative Preferred Stock
Vs.
Noncumulative
Cumulative
Dividends in arrears must be paid before dividends may be paid on common stock.
Undeclared dividends from current and prior years do not have to be paid in future years.
Cumulative preferred stock has the right to be paid in both the current and all prior periods’ unpaid dividends before any dividends are paid to common stockholders. When the preferred stock is cumulative and the directors do not declare a dividend to preferred stockholders, the unpaid dividend is called a dividend in arrears and must be disclosed in the financial statements.
Noncumulative preferred stock has no rights to prior periods’ dividends if they were not declared in those prior periods.
Let’s look at an example.

30. Stock Preferred as to Dividends
Example: Consider the following partial Statement of Stockholders’ Equity.
This company has both common stock and preferred stock. The directors declare a small dividend of $5,000 in In 2008, the directors declare and pay cash dividends of $42,000.
Let’s see how this dividend is distributed if the preferred stock is cumulative, and if it is noncumulative.
During 2007, the directors declare cash dividends of $5,000. In 2008, the directors declare cash dividends of $42,000.

31. Stock Preferred as to Dividends
Part I
Preferred stock receives any declared dividends before common stock. In 2007, the preferred stock received all of the $5,000 in dividends and common stock received none. If the preferred stock is noncumulative, these stockholders have no rights to the missed portion of dividends in the year However, they get first distribution of the dividends declared in The dividend for the preferred stock in 2008 is calculated as follows: $100 par value times 9% times 1,000 shares. Since $42,000 in dividends were declared, preferred would first get $9,000 and the remaining $33,000 would be divided evenly among the common stockholders.
Part II
If the preferred stock is cumulative, the stockholders have rights to the missed dividends in the year 2007 and the full dividends in The preferred stockholders first get a distribution of $42,000 for the missed dividends in Then, they get another $9,000 for the dividends in Since $42,000 in dividends were declared, preferred would first get $13,000 and the remaining $29,000 would be divided evenly among the common stockholders.

32. Other Features of Preferred Stock
I just converted 100 shares of preferred stock into 1,000 shares of common stock and ended up with a higher dividend yield!
Gee, I can’t do that with MY preferred stock!
Some preferred stock is convertible into shares of common stock.
Some preferred stocks have an additional preference to be converted into common stock at the stockholder’s choice.

33. Preferred Stock
This is an example of an equity section of a balance sheet for a company that has both preferred stock and common stock. Notice that each stock is reported separately at its par value.

34. Learning Objective
To discuss the factors affecting the market price of preferred stock and common stock.
Learning objective number 6 is to discuss the factors affecting the market price of preferred stock and common stock.
LO6

35. Market Value Common stock is carried at original issue price.
Accounting by the issuer.
Investments in marketable securities are carried at market value.
For the corporation issuing the stock, the market value on the date of sale can be determined by adding together the par value of the stock with the contributed capital in excess of par value account.
For the investor, the market value of the stock will be in the asset account for marketable securities.
Accounting by the investor.

36. Market Price of Preferred Stock
Factors affecting market price of preferred stock:
Dividend rate
Risk
Level of interest rates
Several factors impact the market price of preferred stock, including the dividend rate on the stock, the risk level of the company, and the interest rates in the market. The return based on market value is called the dividend yield.
The return based on the market value is called the “dividend yield.”

37. Market Price of Common Stock
Factors affecting market price of common stock:
Investors’ expectations of future profitability.
Risk that this level of profitability will not be achieved.
Changes in market value have no impact on the books of the issuer.
The market price of common stock is impacted by expectations of future profitability of the corporation and the risk that this profitability level will not be achieved. Although the market price of its stock is important to the corporation, it is not recorded anywhere in the accounting records of the corporation.

38. Learning Objective
To explain the significance of par value, book value, and market value of capital stock.
Learning objective number 7 is to explain the significance of par value, book value, and market value of capital stock.
LO7

39. Book Value per Share of Common Stock
Preferred stock and preferred dividends in arrears are deducted from total stockholders’ equity.
Total Stockholders’ Equity
Number of Common Shares Outstanding
Part I
The Book Value per Common Share ratio records the amount of stockholders’ equity applicable to common shares on a per share basis. It is calculated as Stockholders’ Equity divided by the Number of Common Shares Outstanding.
Part II
Remember to deduct the preferred stock value and any preferred dividends in arrears from total stockholders’ equity when calculating this ratio for common stock.
Part III
And, remember that book value is not the same as market value. =
Book Value Market Value

40. To explain the purpose and effects of a stock split.
Learning Objective
To explain the purpose and effects of a stock split.
Learning objective number 8 is to explain the purpose and effects of a stock split.
LO8

41. Banana Splits On Sale Now
Stock Splits
Companies use stock splits to reduce market price.
Outstanding shares increase, but par value is decreased proportionately.
Ice Cream Parlor
Banana Splits On Sale Now
Stock splits are the distribution of additional shares of stock to stockholders according to their percent ownership. When a stock split occurs, the corporation calls in the outstanding shares and issues new shares of stock. In the process of a stock split, the par value of the stock changes.
Let’s look at an example.

42. Stock Split
Assume a corporation has 5,000 shares of $1 par value common stock outstanding before a 2–for–1 stock split.
Increase
Decrease
No Change
Part I
This corporation has five thousand shares of one dollar par value stock prior to a 2 for 1 stock split.
Part II
After the split, the number of shares doubled and the par value was cut in half. Notice that an accounting entry is not required.

43. To account for treasury stock transactions.
Learning Objective
To account for treasury stock transactions.
Learning objective number 9 is to account for treasury stock transactions.
LO9

44. No voting or dividend rights
Treasury Stock
Treasury shares are issued shares that have been reacquired by the corporation.
No voting or dividend rights
Contra equity account
Sometimes corporations buy their own stock back in the market. They do this to increase the shares needed in the acquisition of another company, to limit the shares available for a hostile takeover, and to increase shares for use in employee stock option programs.
Treasury stock has no voting or dividend rights. Treasury stock is a contra equity account and is subtracted from the equity section on the balance sheet.
Let’s look at an example.
When stock is reacquired, the corporation records the treasury stock at cost.

45. Treasury Stock - Example
On May 1, 2007, East, Inc. reacquires 3,000 shares of its common stock at $55 per share.
Prepare the journal entry for May 1.
Part I
On May 1st, East Corporation purchased 3,000 of its own shares in the market for $55 per share. Let’s look at the entry for this transaction.
Part II
The entry on May 1st includes a debit to Treasury Stock and a credit to Cash for $165,000, which is the amount of the purchase.
The Treasury Stock account will be reported on the balance sheet in the equity section as a reduction from total equity.

46. Treasury Stock - Example
On December 3, 2007, East Corp. reissued 1,000 shares of the stock at $75 per share.
Prepare the journal entry for December 3.
1,000 shares × $75 = $75,000
Part I
On December 3rd, East Corporation sold 1,000 shares of the treasury stock for $75 per share. Let’s look at the entry to record this transaction.
Part II
This entry includes a debit to Cash for $75,000. The credit to Treasury Stock is for $55,000. This is the original cost of $55 per share times 1,000 shares sold. The difference between the selling price and the cost of the treasury stock is credited to Additional Paid-in Capital from Treasury Stock Transactions. In this example, that amount is $20,000.
1,000 shares × $55 cost = $55,000

47. Stockholders’ Equity - Presentation
On the equity section of the balance sheet, the ending balance in the Treasury Stock account of $110,000 is subtracted. The balance in the Treasury Stock account is from the original debit entry for $165,000 less the credit entry for the sale for $55,000.

48. End of Chapter 11
End of chapter 11. 4