© 2015 Pearson Education, Limited.

Learning Objectives Account for the purchase and sale of treasury stock Explain how equity is reported for a corporation Use earnings per share, rate of return on common stock, and the price/earnings ratio to evaluate business performance © 2015 Pearson Education, Limited.

Identify the characteristics of a corporation
Learning Objective 1 Identify the characteristics of a corporation © 2015 Pearson Education, Limited.

Advantages and Disadvantages of Corporations
The corporation is one of the most familiar forms of business organization. Unlike a sole proprietorship, or a partnership, the corporation holds the status of a separate legal entity, capable of owning property, entering into contracts, and paying taxes. There are several advantages of the corporate form of business over other business forms. Owners (shareholders) of a corporation are shielded from liability for the actions of the corporation. In addition, there is no real limit to the number of owners that a corporation may have. Finally, a corporation has its own “indefinite life.” Even when the owners pass away, the corporation continues to exist. There are also disadvantages to the corporate form of business. Because ownership and management are separated, the issue of agency and incentives becomes important. Essentially, management is expected to act in the best interest of the stockholders. However, in many cases, management acts in their own best interest, to the detriment of the stockholders. Income from a corporation is “double-taxed.” Essentially, income is taxed at the corporate level. Then when the already taxed income is distributed to owners as dividends, the income is taxed again at the personal level of the stockholders receiving the dividend. Other disadvantages include government regulation and oversight, as well as generally higher start-up costs compared to other forms of business. © 2015 Pearson Education, Limited.

Basic Stock Certificate
Ownership in a corporation is represented by stock certificates. A stock certificate, usually very ornate in design to discourage counterfeiting, will include information such as the name of the stockholder, the company name, the number of shares represented by the particular certificate, and the date of issue. Stock certificates may also be serially numbered and are registered. © 2015 Pearson Education, Limited.

Categories of Stock Authorized Shares—The maximum number of shares of stock that a company can issue. It is specified in the company’s charter. Issued Shares—The total number of a company’s shares that have been sold over time. Outstanding shares—The number of shares of a corporation’s stock that are in the hands of investors. Treasury Shares—The number of issued shares that have been previously issued and later reacquired by the corporation. © 2015 Pearson Education, Limited.

Stockholder Rights Vote (1 share = 1 vote) Dividends (entitled to a proportionate share of dividends) Liquidation (entitled to share in proceeds from a liquidation) Preemptive Ownership Rights (entitled to maintain % ownership) Investors receive an ownership interest in the form of shares of common stock. All common stockholders have certain rights associated with ownership. Stockholders have certain rights of ownership. The most important right is the right to vote at the annual stockholders’ meeting. In almost all cases, one share equals one vote. So the more shares you own, the more “votes” you get. Issues voted on include members nominated for positions on the board of directors and certain policy issues such as the approval of the audit firm or mergers with other companies. Stockholders have the right to receive a proportional share of any dividends declared by the company and to share proportionately in a distribution of available cash proceeds in the event that the company is liquidated. Finally, stockholders have a preemptive ownership right. This entitles stockholders to purchase additional shares of stock when the company issues new shares, in amounts sufficient to maintain their percentage ownership. On occasion, when a company desires to purchase another company using a new issuance of stock, stockholders will be asked to suspend their preemptive stock ownership rights in the interest of company growth. © 2015 Pearson Education, Limited.

Preferred Stock A separate class of stock, typically having priority over common shares in . . . Dividend distributions. Distribution of assets in case of liquidation. Usually callable by the company. Preferred is a special class of stock with unique characteristics. Primarily, preferred stockholders receive preference in the distribution of dividends. Because of the unique structure of preferred stock, the amount of dividends that a preferred stockholder will receive when dividends are declared is pre-determined by the preferred stock contract. For example, a 5% preferred stock will receive 5% of par value when a dividend is declared. When the Board of Directors declares a dividend, the amount that will go to the preferred stockholders is taken out first, before determining how much each common shareholder will receive. In addition to a preference with respect to dividends, preferred stock usually has no voting rights. Usually states the dividend rate as a percent of par value. Normally no voting rights. © 2015 Pearson Education, Limited.

Journalize the issuance of stock
Learning Objective 2 Journalize the issuance of stock © 2015 Pearson Education, Limited.

Issuing Common Stock debit Cash received credit Common Stock for the number of shares issued x par value credit Paid-In Capital in Excess of Par for the excess of issue price over par value NYSE NASDAQ When common stock is issued, the company will receive cash from the new investors. In addition, the claims against the assets will increase, so the equity accounts of Common Stock and Paid-In Capital in Excess of Par are increased to reflect the investment of the new stockholders. The entry will include a debit to Cash. In addition, there will be a credit to Common Stock for the number of shares issued x the par value per share (for par value stock). The remainder of the receipt from the stock issuance are credited to Paid-In Capital in Excess of Par. © 2015 Pearson Education, Limited.

Issuing Common Stock at Par
Smart Touch Learning sells 1,000,000 shares of stock on January 1 for $1 per share. The par value of the shares is $1 per share. Smart Touch Learning sells 1,000,000 shares of its $1 par value common stock for $1 per share. Prepare the entry to record this issuance of common stock. Prepare the journal entry to record Smart Touch Learning’s issuance of common stock. © 2015 Pearson Education, Limited.

Issuing Common Stock at Par
Smart Touch Learning sells 1,000,000 shares of stock on January 1 for $1 per share. The par value of the shares is $1 per share. The entry will include a debit to Cash for $1,000,000 and a credit to Common Stock for $1,000,000 (1,000,000 shares issued x $1 par value per share). © 2015 Pearson Education, Limited.

Issuing Common Stock at a Premium
Smart Touch Learning sells 1,000,000 shares of stock on January 2 for $20 per share. The par value of the shares is $1 per share. In this example, Smart Touch Learning sells 1,000,000 of its $1 par value common stock for $20 per share. Prepare the journal entry to record this issuance of common stock. Prepare the journal entry to record Smart Touch Learning’s issuance of common stock. © 2015 Pearson Education, Limited.

Issuing Common Stock at a Premium
Smart Touch Learning sells 1,000,000 shares of stock on January 2 for $20 per share. The par value of the shares is $1 per share. Then entry will include: A debit to Cash for $20,000,000 (1,000,000 shares issued x $20 per share) A credit to Common Stock for $1,000,000 (1,000,000 shares issued x $1 par value per share) A credit to Paid-In Capital in Excess of Par for $19,000,000. © 2015 Pearson Education, Limited.

Reporting Common Stock
On the balance sheet, the issuance will be reflected in the equity section. Common Stock and Paid-In Capital in Excess of Par are considered to be “capital” accounts. Retained Earnings is the other account that makes up the equity section at this point. Notice that for Common Stock there are several pieces of information that accompany the account title; par value per share, number of shares authorized, and number of shares issued and outstanding. This information is required by GAAP to be disclosed on the balance sheet. © 2015 Pearson Education, Limited.

Issuing Preferred Stock
Smart Touch Learning issues 1,000 shares of its $50 par, 6% preferred stock on January 3 at $55 per share. Issuing Preferred Stock follow a similar process to the issuance of common stock. Smart Touch Learning issues 1,000 shares of its $50 par value, 6% preferred stock on January 3 for $55 per share. Record the issuance of these preferred shares. Prepare the journal entry to record Smart Touch Learning’s issuance of preferred stock. © 2015 Pearson Education, Limited.

Issuing Preferred Stock
Smart Touch Learning issues 1,000 shares of its $50 par, 6% preferred stock on January 3 at $55 per share. As with Common Stock, Cash is debited for the amount of cash received ($55,000 = 1,000 shares issued x $55 per share). Preferred Stock is credited for the number of shares issued x the par value per share ( 1,000 shares issued x $50 par value per share). Because the dividends on preferred stock are calculated from the par value of the shares, most companies assign a substantial par value to preferred stock; often $50 per share or $100 per share). Finally, Paid-In Capital in Excess of Par for Preferred Stock is credited for $5,000, the difference between the cash proceeds and the par value of the shares issued. Note that Common Stock and Preferred Stock have their own Paid-In Capital in Excess of Par accounts. © 2015 Pearson Education, Limited.

Reporting Preferred Stock
On the balance sheet, Preferred Stock is recorded in the equity section, usually before the Common Stock. © 2015 Pearson Education, Limited.

Account for cash dividends, stock dividends, and stock splits
Learning Objective 3 Account for cash dividends, stock dividends, and stock splits © 2015 Pearson Education, Limited.

Dividend Accounting Time Line
Declaration date Board of directors declares the dividend and it becomes a liability. Record Date Stockholders holding shares on this date will receive the dividend. Payment Date Record the payment of the dividend to stockholders. Not legally required. Requires sufficient Cash and Retained Earnings. Dividends are not required for any corporation. They are only paid after the Board of Directors “declares” that a dividend will be paid to the stockholders. The Board of Directors decides the total amount of the dividend to be distributed, or in some cases, may decide how much dividend to pay per common share. In either case, when the dividends are declared, they become a legal liability for the company and must be recorded as a liability at that point. There are three critical dates associated with the declaration and payment of dividends. Declaration Date—on this date, the Board of Directors votes to pay a dividend. This action creates a dividend liability that must be recorded. Record Date—no transactions related to the dividend need be recorded at this point. However, only investors who actually own the stock on the Record Date will be entitled to receive the related dividend. Payment Date—on this date (which can be anywhere from a couple of weeks or a month past the Declaration Date), dividend checks are mailed to the stockholders of record on the Record Date. The dividend payable is satisfied and a cash payment is recorded. © 2015 Pearson Education, Limited.

Declaration date Record Date Payment Date No entry On the Payment Date, the company will record a debit to Dividends Payable and a credit to Cash to indicate that the dividends have been paid. © 2015 Pearson Education, Limited.

Recording Dividends On May 1, Smart Touch Learning’s Board of Directors declares a $0.25 per share cash dividend on 2,000,000 outstanding shares of common stock. On May 1, Smart Touch Learning’s Board of Directors declares a $0.25 per common share dividend on the 2,000,000 outstanding shares of common stock. Record the journal entry for the declaration of the dividend. Prepare the journal entry to record Smart Touch Learning’s declaration of a cash dividend. © 2015 Pearson Education, Limited.

Recording Dividends On May 1, Smart Touch Learning’s Board of Directors declares a $0.25 per share cash dividend on 2,000,000 outstanding shares of common stock. The entry will require a debit to Retained Earnings (which will reduce Retained Earnings, indicating that some of the accumulated earnings have now been committed to the stockholders.) In addition, the company will credit Dividend Payable. © 2015 Pearson Education, Limited.

On May 30, Smart Touch Learning pays the dividend to its stockholders.
Recording Dividends On May 30, Smart Touch Learning pays the dividend to its stockholders. On May 30, Smart Touch Learning pays the dividend to its stockholders. Prepare the journal entry. Prepare the journal entry to record Smart Touch Learning’s payment of a cash dividend. © 2015 Pearson Education, Limited.

On May 30, Smart Touch Learning pays the dividend to its shareholders.
Recording Dividends On May 30, Smart Touch Learning pays the dividend to its shareholders. The entry will require a debit to Dividends Payable and a credit to Cash for $500,000 (2,000,000 shares outstanding x $0.25 per share) © 2015 Pearson Education, Limited.

Dividends in arrears do not have to be paid in future years.
Preferred Dividends Preferred dividends are determined by contract and get paid before dividends on common stock. Cumulative vs Noncumulative Dividends in arrears must be paid before dividends may be paid on common stock. Dividends in arrears do not have to be paid in future years. Preferred stockholders also receive a portion of the dividends declared by the Board of Directors. Because of their “preferred” status, the preferred stockholders will receive their dividends first from the total dividends declared by the Board of Directors, with the remainder being distributed to the Common Stockholders. On the preferred stock certificate (contract), the amount of the dividends for the preferred shares will be indicated as a percentage of the par value. Although this is not a guarantee that a dividend will be paid, it does define how much the dividend will be if a dividend is declared by the Board of Directors. For example, if a preferred stock has a $100 par value and is designated as having a 6% dividend, then the shareholder will receive $6 per share dividends ($100 x 6%) if the Board of Directors declares a dividend. The preferred dividend can be designated as Cumulative or Noncumulative. If the dividend is noncumulative, then any undeclared dividend is lost forever. If the dividend is cumulative, then any undeclared dividend for the current year will be designated as a “dividend in arrears” and will carried forward to be paid out of future dividends should they be declared. © 2015 Pearson Education, Limited.

Preferred Dividends Fast forward to Smart Touch Learning’s preferred stock is cumulative. They did not declare any dividends in In 2016, the Board of Directors declares a $50,000 dividend. Smart Touch Learning issued 1,000 shares of $50 par value, 6% preferred stock on January 3. There were no dividends declared or paid in In 2016, the Board of Directors declared a $50,000 dividend, to be split between the preferred stockholders and the common stockholders. The investors holding the 1,000 shares of preferred stock are entitled to be paid first. In addition, the first amount they will receive is the dividends in arrears for Then they will be paid the dividends for The dividends in arrears amounts to $3,000 (1,000 x $50 par value x 6%). The dividends for 2016 will be $3,000. So, the first $6,000 ($3,000 dividends in arrears + $3,000 dividends for 2016) will go to the preferred stockholders, leaving $44,000 to be paid to the common stockholders. © 2015 Pearson Education, Limited.

Preferred Dividends The entry will include: a debit to Retained Earnings for $50,000 a credit to Dividends Payable—Common for $44,000 a credit to Dividends Payable—Preferred for $6,000 © 2015 Pearson Education, Limited.

Accounting for Stock Dividends
Distribution of additional shares of stock to stockholders No change in total stockholders’ equity No change in par values Sometimes, a company will decide to forego a cash dividend in favor of a stock dividend. Issuing a stock dividend allows the company to issue something of value to the stockholders without having to pay cash. A stock dividend will not change the total stockholders equity for the company. There will be no changes in par value and all stockholders will retain their percentage of ownership. All stockholders retain same percentage ownership © 2015 Pearson Education, Limited.

The Difference Between Small and Large Stock Dividends
Small Stock Dividend Stock dividend < 20% to 25% Debit R/E for the market value of stock issued. Credit Common Stock and Paid-In Capital. Large Stock Dividend Stock dividend > 20% to 25% Debit R/E for the par value of the shares issued. Credit Common Stock. Stock dividends can be divided into two types, each with distinctive accounting: Small Stock Dividends—a stock dividend that represents an issuance of new stock that is less than 20% to 25% of the total outstanding common shares (the 20% to 25% range allows for some judgment). Accounting for a small stock dividend will require a debit to R/E for the market value of the additional shares issued and a credit to Common Stock (for the par value of the shares issued) and a credit to Paid-In Capital in Excess of Par. Large Stock Dividends—a stock dividend that represents an issuance of new stock that is in excess of 20% to 25% of the total outstanding common shares. Accounting for a large stock dividend requires a debit to R/E for the par value of the shares issued and a credit to Common Stock for the par value of the shares issued. © 2015 Pearson Education, Limited.

Stock Splits Smart Touch Learning has 3,150,000 shares of $1 par value stock outstanding. A 2-for-1 stock split will result in 6,300,000 shares with a par value of $0.50 per share. Increases both the number of issued shares and outstanding shares. Stock after the split has a proportionately lower par value. Total capital amount of the common stock account does not change When an issuance of new stock is greater than 100% of the currently outstanding common shares, then the distribution of stock is designated as a Stock Split. When a stock split occurs, the accounting will show an increase in the number of outstanding shares and a corresponding decrease in the par value of the outstanding shares that is proportionate and sufficient to insure that the Common Stock account does not change value. For example, suppose that Smart Touch Learning has 3,150,000 shares of $1 par value common stock outstanding. If they issued a 2-for-1 stock split, the number of shares outstanding will increase to 6,300,000. In addition, the par value of those shares will be decreased from $1 par value to $0.50 par value. Often a stock split will also result in a corresponding, proportionate decrease in the market value of the shares. © 2015 Pearson Education, Limited.

Account for the purchase and sale of treasury stock
Learning Objective 4 Account for the purchase and sale of treasury stock © 2015 Pearson Education, Limited.

Treasury Stock Recorded at cost Appears as a contra-equity account
Companies will sometimes reacquire their own stock from the market. Recorded at cost Appears as a contra-equity account No voting or dividend rights Used to: support the company’s stock price sell to employees at a discount fulfill stock option obligations Companies will sometimes reacquire their own shares from the market. When the company reacquires shares, the law of supply and demand will inevitably support a higher market value for the remaining outstanding shares. The reacquired shares will be stored for later re-distribution to employees, officers, as stock dividends, or perhaps as “currency” in an acquisition. While the company’s shares are held as “treasury stock”, the shares have no voting or dividend rights. Treasury stock will be recorded at cost and will be reported as a contra-equity account in the equity section of the balance sheet. © 2015 Pearson Education, Limited.

Recording Treasury Stock
On May 31, Smart Touch Learning purchased 1,000 shares of previously issued common stock, paying $5 per share. On May 31, Smart Touch Learning purchased 1,000 shares of previously issued common stock, paying $5 per share. Record the acquisition of treasury stock. Prepare the journal entry to record the purchase of treasury stock. © 2015 Pearson Education, Limited.

Recording Treasury Stock
On May 31, Smart Touch Learning purchased 1,000 shares of previously issued common stock, paying $5 per share. The entry will require a debit to Treasury Stock for $5,000 (1,000 shares x $5 per share cost) and a credit to Cash for $5,000. © 2015 Pearson Education, Limited.

Reporting Treasury Stock
As shown in Exhibit 13-10, Treasury Stock is reported in the equity section as a contra-equity account. © 2015 Pearson Education, Limited.

Explain how equity is reported for a corporation
Learning Objective 5 Explain how equity is reported for a corporation © 2015 Pearson Education, Limited.

Statement of Retained Earnings
Shows how the R/E balance changed during the period. The Statement of Retained Earnings only shows us the changes in the Retained Earnings account from the beginning of the period to the end of the period. © 2015 Pearson Education, Limited.

Prior-Period Adjustments
Errors from prior periods that must be corrected to make the R/E balance correct. Adjust beginning R/E. In addition to Net Income, Net Losses, and Dividends, there is an additional potential accounting item than can impact Retained Earnings; a Prior Period Adjustment. When a company discovers errors in previous statements, rather than correct the previous statements for the error, a company will show the cumulative effect of the error as an adjustment to Retained Earnings referred to as a Prior Period Adjustment. © 2015 Pearson Education, Limited.

Statement of Stockholders’ Equity
Shows the changes in all equity accounts for the period. Publicly traded companies will likely use a Statement of Stockholders’ Equity instead of a Statement of Retained Earnings. The Statement of Stockholders’ Equity will show the changes in all the accounts that make up the equity section of the Balance Sheet. © 2015 Pearson Education, Limited.

>TRY IT! Sjostrom, Inc. had beginning retained earnings of $300,000 on January 1, During the year, Sjostrom declared and paid $140,000 of cash dividends and earned $200,000 of net income. Prepare a statement of retained earnings for Sjostrom, Inc. for the year ending December 31, 2014. Sjostrom, Inc. had beginning R/E of $300,000 on January 1, During the year, they declared dividends of $140,000 and earned $200,000 of net income. Prepare a Statement of R/E for the year ending December 31, 2014. © 2015 Pearson Education, Limited.

>TRY IT! The Statement of Retained Earnings will show the beginning balance of R/E at January 1, 2014 as $300,000. We add the $200,000 of Net Income and deduct the $140,000 of declared dividends. The ending balance for R/E will be $360,000 and will appear on the December 31, 2014 balance sheet. © 2015 Pearson Education, Limited.

Earnings Per Share A measure of the net income of the company expressed as an amount per each share of common stock outstanding. Companies report earnings per share only for common stock. EPS is reported on the income statement. Earnings Per Share is computed as (Net Income – Preferred Dividends) ÷ Average # of Common Shares Outstanding. This amount is computed only for Common Stock and is reported on the income statement. © 2015 Pearson Education, Limited.

Earnings Per Share Using the numbers below, compute the EPS for Green Mountain Coffee Roasters Examine the information for Green Mountain Coffee Roasters. Compute Earnings Per Share for 2011. © 2015 Pearson Education, Limited.

Earnings Per Share Net Income for 2011 for Green Mountain Coffee Roasters is $199,501,000. Preferred dividends are $0. The average # of common shares outstanding is 143,645,024 (computed as the ending 2010 common shares of 132,823,585 + ending 2011 common shares of 154,466,463 shares) ÷ 2. In this case: (132,823, ,466,463) ÷ 2 = 143,645,024 The 2011 Earnings Per Share = $199,501,000 ÷ 143,645,024 = $1.39 per share. © 2015 Pearson Education, Limited.

Price/Earnings Ratio Ratio of market price of a share of common stock to the company’s earnings per share. A higher PE Ratio signifies a higher return on investment. The Price-Earnings (P/E) Ratio is a ratio of the market price of each share of common stock to the company’s EPS. P/E Ratio = Market Price per Share ÷ EPS © 2015 Pearson Education, Limited.

Price/Earnings Ratio Assuming Green Mountain Coffee Roasters, Inc. has a market price of $17.90 per share of common stock. Their EPS is $1.39 per share. Assume that the market price for Green Mountain Coffee Roasters has a market price of $17.90 per share at the end of Compute P/E Ratio for 2011. © 2015 Pearson Education, Limited.

Price/Earnings Ratio Assuming Green Mountain Coffee Roasters, Inc. has a market price of $17.90 per share of common stock. Their EPS is $1.39 per share. The P/E Ratio = Market Price Per Share ÷ EPS = $17.90 ÷ $1.39 = 12.88 © 2015 Pearson Education, Limited.

Rate of Return on Common Stock
Also called Return on Equity Using the information for Green Mountain Coffee Roasters, compute Return on Equity The Rate of Return on Common Stock is also referred to as the Return on Equity. It is computed as: (Net Income – Preferred Dividends) ÷ Average Common Stockholder’s Equity Using the information for Green Mountain Coffee Roasters, compute the Return on Equity for 2011. © 2015 Pearson Education, Limited.

Rate of Return on Common Stock
The Return on Equity = ($199,501,000 - $0) ÷ $1,305,730,000 = 15% © 2015 Pearson Education, Limited.

Compute Vollmer Inc.’s Return on Common Stockholders Equity for 2015.
>TRY IT! Match the accounting terms below to the proper definitions. Compute Vollmer Inc.’s Return on Common Stockholders Equity for 2015. © 2015 Pearson Education, Limited.

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