1. Financial Accounting: Tools for Business Decision Making, 2nd Ed.
Kimmel, Weygandt, Kieso
Prepared by:
Ellen L. Sweatt
Georgia Perimeter College
ELS

2. Reporting and Analyzing
Chapter 11 `
Reporting and Analyzing
Stockholders' Equity

3. Chapter 11 Reporting and Analyzing Stockholders’ Equity
After studying Chapter 11, you should be able to:
Identify and discuss the major characteristics of a corporation.
Record the issuance of common stock.
Explain the accounting for purchase of treasury stock.
Differentiate preferred stock from common stock.

4. Chapter 11 Reporting and Analyzing Stockholders’ Equity
After studying Chapter 11, you should be able to:
Prepare the entries for cash dividends and stock dividends.
Identify the items that affect retained earnings.
Prepare a comprehensive stockholders' equity section.
Evaluate a corporation's dividend and earnings performance from a stockholder's perspective.

5. Corporation Possess legal entity Created by law
Has most of the rights and privileges of a person
Classified by purpose and ownership
Purpose - profit or nonprofit
Ownership - publicly or privately held

6. Publicly Held Corporation...
May have thousands of stockholders and its stock is regularly traded on national securities markets.

7. Privately Held Corporation...
May have few stockholders and does not offer its stock for sale to general public.

8. Characteristics of a Corporation
Separate legal existence
Limited liability of stockholders
Transferable ownership rights
Ability to acquire capital
Continuous life
Corporation management
Government regulations
Additional taxes

9. Separate Legal Existence
Separate and distinct from owners.
Acts under its own name.
May buy, own, sell property; borrow money; enter into legally binding contracts; may sue or be sued; pays its own taxes.
Owners (stockholders) cannot bind corporation unless owners are agents of the corporation.

10. Limited Liability of Stockholders
Creditors have recourse only to corporate assets to satisfy claims.
Liability of stockholders limited to investment in corporation.
Creditors have no legal claim on personal assets of owners unless fraud has occurred.

11. Transferable Ownership Rights
Ownership evidenced by shares of stock
Transfer of ownership among stockholders has no effect on corporation’s operating activities or assets, liabilities and total stockholders' equity.
Corporation does not participate in transfer of ownership rights after original sale.

12. Ability to Acquire Capital
Limited liability of stockholders coupled with transferable ownership rights make it easy to raise capital.

13. Continuous Life
Life of corporation stated in charter - may be perpetual or limited to specific number of years (can be extended).
Corporation is separate legal entity, thus life not affected by withdrawal, death, or incapacity of stockholder.

14. Forming a Corporation
A corporation can operate in various states (must have a license from each state in which it does business) but can be incorporated in only one state.

15. Corporation Management
The corporation establishes by-laws upon receipt of its charter from the state of incorporation.
Stockholders manage corporation indirectly through board of directors.
Board of directors
formulates operating policies
selects officers to execute policy and to perform daily management functions.

16. Corporate Organization Chart
Illustration 11-1
Corporate Organization Chart

17. Page 513 of text

18. Additional Taxes Corporations pay federal and state income taxes.
Stockholders pay taxes on cash dividends Corporate income is taxed twice.

19. Stockholder Rights Once chartered, the corporation sells stock .
If only one class of stock - called common stock.
Ownership rights specified in the articles of incorporation or by-laws.
Proof of stock ownership is a printed or engraved form known as stock certificate.

20. Illustration 11-3

21. Stock Certificate Shows...
Illustration 11-4
Stock Certificate Shows...
name of the corporation
stockholder's name
class and special features of the stock
the number of shares owned
the signatures of duly authorized corporate officials.

22. Questions in Issuing Stock...
How many shares should be authorized for sale?
How should the stock be issued?
At what price should the shares be issued?
What value should be assigned to the stock?

23. Authorized Stock... Outstanding Stock...
Maximum amount of stock a corporation is allowed to sell as authorized by corporate charter.
Outstanding Stock...
Number of shares of issued stock
that are being held by stockholders.

24. Corporations Can Issue Stock...
Directly to investors (typical in privately held corporations).
Indirectly through an investment banking firm (customary with publicly held corporations).

25. Factors Involved in Setting Price of Stock...
Company's anticipated future earnings
Its expected dividend rate per share
Its current financial position
Current state of the economy
Current state of the securities market

26. Par Value Stock...
Is capital stock that has been assigned an arbitrary value per share in the corporate charter.
Is usually low because some states levy a tax on the corporation based on par value.
The legal capital per share that must be retained in the business.

27. Par Value and Stated Value have NO relationship to market value.
No-Par Value Stock...
Capital stock that has not been assigned a value per share in the corporate charter.
Stated Value of No-Par Stock
Amount per share assigned by the board of directors to no-par stock.
Par Value and Stated Value have NO
relationship to market value.

28. Relationship of Par and No-Par Value to Legal Capital
Illustration 11-5

29. Stockholders’ Equity Section of a Corporation’s Balance Sheet...
Two Parts:
Paid-in (contributed) capital
Retained earnings (earned capital).

30. Paid-in Capital... Retained Earnings...
Amount paid to corporation by stockholders for shares of ownership.
Retained Earnings...
Earned capital held for future use in the business.

31. Accounting for Common Stock Issues
The issue of common stock affects only paid-in capital accounts.
When the issuance of common stock for cash is recorded, the par value of the shares is credited to Common Stock.
The portion of the proceeds above or below par value is recorded in a separate paid-in capital account.

32. Issuing Stock at Par
Assume Hydro-Slide, Inc., issues 1,000 shares of $1 par value of common stock at par for cash.
Cash 1, Common Stock 1,000

33. Issuing Stock Above Par
If Hydro-Slide, Inc., issues an additional 1,000 shares of the $1 par value common stock for cash at $5 per share, the entry is:
Cash 5,000
Common Stock 1,000
Paid-in Capital in 4,000
Excess of Par Value

34. Balance Sheet (partial)
Hydro-Slide, Inc.
Balance Sheet (partial)
Illustration 11-6
Stockholders' equity
Paid-in capital
Common stock $ 2,000
Paid-in capital in excess of par ,000
Total paid-in capital $ 6,000
Retained earnings ,000
Total stockholders' equity $33,000

35. Balance Sheet (partial) BEFORE TREASURY STOCK TRANSACTION
Mead, Inc.
Balance Sheet (partial)
Illustration 11-7
Stockholders' equity
Paid-in capital
Common stock,$5par value,
100,000 shares issued and
outstanding $ 500,000
Retained Earnings ,000
Total stockholders’ equity $ 700,000
BEFORE TREASURY STOCK TRANSACTION

36. Treasury Stock... Is a corporation's own stock that has been issued
fully paid for
reacquired by the corporation
held in its treasury for future use.

37. Corporations Acquire Treasury Stock to...
Reissue shares to officers and employees under bonus and stock compensation plans.
Increase trading of company's stock in securities market in hopes of enhancing market value.
Have additional shares available for use in acquisition of other companies.
Reduce number of shares outstanding thereby increasing earnings per share.
Prevent a hostile takeover.

38. Purchase of Treasury Stock
On February 1, 2001, Mead acquires ,000 shares of its stock at $8 per share.
Treasury Stock 32,000
Cash ,000

39. Treasury Stock
The Treasury Stock account would increase by the cost of the shares purchased - $32,000.
The original paid-in capital account, Common Stock, would not be affected because the number of issued shares does not change.
Treasury stock is deducted from total paid-in capital and retained earnings in the stockholders' equity section of the balance sheet.

40. Balance Sheet (partial) AFTER TREASURY STOCK TRANSACTION
Mead, Inc.
Balance Sheet (partial)
Illustration 11-8
Stockholders' equity
Paid-in capital
Common stock,$5par value,
100,000 shares issued and
96,000 outstanding $ 500,000
Retained Earnings ,000
Total stockholders’ equity ,000
Less: Treasury Stock ,000
Total stockholders’ equity $ 668,000
AFTER TREASURY STOCK TRANSACTION

41. Preferred Stock...
Capital stock that has contractual preferences over common stock in certain areas.
Dividends
Assets in the event of liquidation
Preferred stockholders do not have voting rights.

42. Preferred Stock
Assume Corporation issues 10,000 shares of $10 par value preferred stock for $12 cash per share.
Cash ,000
Preferred Stock ,000
Paid-in Capital in Excess ,000
of Par Value--Preferred Stock
(Preferred stock may have either a par value or no-par value.)

43. Dividend Preferences
Preferred stockholders have the right to share in the distribution of corporate income before common stockholders.
The first claim to dividends does not guarantee dividends.

44. Cumulative Dividend...
Is a feature of preferred stock entitling the stockholder to receive current and unpaid prior-year dividends before common stockholders receive any dividends.

45. Dividends in Arrears...
Are preferred dividends that were scheduled to be declared but were not declared during a given period.
Are not a liability. No liability exists until a dividends is declared by board of directors.
Must be disclosed in the notes to the financial statements.

46. Illustration 11-9
Dividends in Arrears
Scientific-Leasing has 5,000 shares of 7%, $100 par value cumulative preferred stock outstanding.
The annual dividend is $35,000 (5,000 x $7 per share).
Dividends are 2 years in arrears
Dividends in arrears ($35,000 x 2 years) $ 70,000 Current-year dividends ,000 Total preferred dividends $105,000

47. Liquidation Preference
Is a feature that gives preferred stockholders preference to corporate assets in the event of liquidation.

48. Dividend...
Is a distribution by a corporation to its stockholders on a pro rata basis.
Pro rata means that if you own 10% of the common shares, you will receive 10% of the dividend.
Dividend forms:
cash
property
script (promissory note to pay cash)
stock.

49. Cash Dividend Is a pro rata distribution of cash to stockholders.
A corporation must have things to pay cash dividends:
Retained earnings
Adequate cash
Declared dividends

50. Cash Dividend
In many states, payment of dividends from legal capital is illegal.
Payment of dividends from paid-in capital in excess of par is legal in some states.
Payment of dividends from retained earnings is legal in all states.
Companies are frequently constrained by agreements with lenders to pay dividends only from retained earnings.

51. Entries for Cash Dividends
Three dates are important in connection with dividends:
the declaration date
the record date
the payment date

52. The Declaration Date...
Is the date the board of directors declares the cash dividend.
Commits the corporation to a binding legal obligation that cannot be rescinded.
On December 1, 2001 the directors of Media General declare a $.50 per share cash dividend on 100,000 shares of $10 par value common stock.
The dividend is $50,000 (100,000 x $.50).
12/1 Retained Earnings ,000
Dividends Payable ,000

53. The Record Date... The Payment Date...
The date ownership of the outstanding shares is determined for dividend purposes. 12/ No Entry Necessary.
The Payment Date...
The date dividend checks are mailed.
January 20 is the payment date for Media General.
1/20 Dividends Payable ,000
Cash ,000

54. A Stock Dividend...
Is a pro rata distribution of the corporation's own stock to stockholders.
Is paid in stock.
Results in a decrease in retained earnings and an increase in paid-in capital.
Does not decrease total stockholders' equity or total assets.
Is often issued by companies that do not have adequate cash to issue a cash dividend.

55. Stock Dividends
You have a 2% ownership interest in Cetus Inc., owning 20 of its 1,000 shares of common stock.
In a 10% stock dividend, 100 shares (1,000 x 10%) of stock would be issued. You would receive two shares (2% x 100), but your ownership interest would remain at 2% (22 /1,100).
You now own more shares of stock, but your ownership interest has not changed.

56. Reasons for Stock Dividends
To satisfy stockholders' dividend expectations without spending cash.
To increase marketability of its stock by increasing number of shares outstanding and decreasing market price per share.
To emphasize that a portion of stockholders' equity has been permanently reinvested in business and is unavailable for cash dividends.

57. Stock Dividends
A small stock dividend (less than 20%-25% of the corporation's issued stock) is recorded at the fair market value per share.
A large stock dividend (greater than 20%-25% of the corporation's issued stock) is recorded at par or stated value per share.

58. Stock Dividends Retained Earnings 75,000
Medland Corporation has $300,000 in retained earnings and declares a 10% stock dividend on its 50,000 shares of $10 par value common stock.
The current fair market value of the stock is $15 per share.
Retained Earnings ,000
Common Stock Dividends ,000 Distributable Paid-in Capital in Excess , of Par Value

59. Stock Split...
Is the issuance of additional shares of stock to stockholders accompanied by:
A reduction in the par or stated value.
An increase in number of shares.
A stock split does not have any effect on total paid-in capital, retained earnings, and total stockholders' equity

60. Stock Split
Because a stock split does not affect the balances in stockholders' equity accounts, it is not necessary to journalize a stock split.

61. Retained Earnings... Is net income that is retained in the business.
The balance in retained earnings is part of the stockholders' claim on the total assets of the corporation.
Retained earnings does not represent a claim on any specific asset.

62. Deficit...
Is a debit balance in retained earnings and is reported as a deduction in the stockholders' equity section of the balance sheet.

63. Retained Earnings Restrictions...
Are legal, contractual or voluntary circumstances that make a portion of retained earnings currently unavailable for dividends.

64. Balance Sheet (Partial)
Kmart, Inc.
Balance Sheet (Partial)
(in millions)
Illustration 11-18
Stockholders' equity
Common stock, $.01 par value;
1,500,000,000 shares authorized ,000,000; 493,358,504
shares issued $ Capital in excess of par value ,667
Retained earnings ,819
Total stockholders' equity $ ,979

65. TOTAL CASH DIVIDENDS DECLARED ON COMMON STOCK
Illustration 11-19
The Payout Ratio =
TOTAL CASH DIVIDENDS DECLARED ON COMMON STOCK
NET INCOME
… measures the percentage of earnings distributed in the form of cash dividends to common stockholders.

66. Illustration 11-19
The Dividend Yield =
DIVIDENDS DECLARED PER SHARE OF COMMON STOCK
STOCK PRICE AT END OF YEAR
…reports the rate of return an investor earned from dividends.

67. Illustration 11-21
Earnings Per Share =
NET INCOME - PREFERRED STOCK DIVIDENDS
AVERAGE COMMON SHARES OUTSTANDING
...measures the net income earned on each share of common stock.

68. Price-Earnings Ratio =
Illustration 11-21
Price-Earnings Ratio =
MARKET PRICE PER SHARE OF STOCK
EARNINGS PER SHARE
In order to make a meaningful comparison of earnings across firms, use the price-earnings ratio.
The price-earnings ratio reflects the investors' assessment of a company's future earnings.

69. Return on Common Stockholders’ Equity Ratio =
Illustration 11-23
Return on Common Stockholders’ Equity Ratio =
NET INCOME -PREFERRED STOCK DIVIDENDS
AVERAGE COMMON STOCKHOLDERS’ EQUITY
...measures the profitability from the stockholders’ point of view.