1. Equity Financing - Learning Objectives
1. Identify the rights associated with ownership of common and preferred stock.
2. Record the issuance of stock for cash, on a subscription basis, and in exchange for noncash assets or for services.
3. Use both the cost and par value methods to account for stock repurchases.
Account for the issuance of stock rights and stock warrants.
Explain the difference between the intrinsic value and fair value methods, and use both in accounting for a fixed stock option plan.
6. Distinguish between stock conversions that require a reduction in retained earnings and those that do not.
7. List the factors that impact the retained earnings balance.

2. Learning Objectives
8. Properly record cash dividends, property dividends, small and large stock dividends, and stock splits.
9. Explain the background of unrealized gains and losses recorded as direct equity adjustments, and list the major types of equity reserves founds in foreign balance sheets.
10. Prepare a statement of changes in stockholders’ equity.

3. Common Stock
The owners of common stock of a corporation can be thought of as the true owners of the business.
Unless restricted by terms of the articles of incorporation, the common stockholder has certain basic rights.

4. Common Stock
The right to vote in the election of directors and in the determination of certain corporate polices such as the management compensation plan or major corporate acquisitions.
The right to maintain one’s proportional interest in the corporation through purchase of additional common stock if and when it is issued.

5. Common Stock
Rex Corporation issued 5,000 shares of common stock with a par value of $1 on April 1, 2005, for $30,000 cash.
Apr. 1 Cash 30,000
Common Stock 5,000
Additional Paid-In
Capital 25,000
at Par Value

6. Preferred Stock The title “preferred” stock is somewhat misleading.
Preferred isn’t better; it’s different.

7. The rights of ownership given up by preferred stockholders:
Voting: In most cases, preferred stockholders are not allowed to vote for the board of directors.
Sharing in success: The cash dividends received by preferred stockholders are usually fixed in amount. If the company does exceptionally well, preferred stockholders do not get to share in the success.

8. The protection enjoyed by preferred stockholders is:
Cash dividend preference: Preferred stockholders are entitled to receive their full cash dividend before any cash dividend can be issued to common stockholders.
Liquidation preference: If the company goes bankrupt, preferred stockholders are entitled to have their investment repaid in full, before common stockholders receive anything.

9. Preferred Stock
Cumulative
Has the right to receive accumulated dividends before any dividends may be paid to common stockholders.
Non-
Cumulative
Has no right to “passed”
dividends.
Participating
Has claim to a portion of
common dividends after
receiving preferred dividends.

10. Preferred Stock Convertible Callable Redeemable
Permits the holder to exchange
preferred stock for common stock.
Callable
Permits the issuing company
to redeem the preferred stock.
Redeemable
Permits the holder to redeem the
stock—usually with some
restrictions.

11. Preferred Stock
Dividends on cumulative preferred stock that are passed are referred to as dividends in arrears.
And… dividends are not a liability until declared by the board of directors.

12. Preferred Stock
Participating preferred stock issues provide for additional dividends to be paid to preferred stockholders after dividends of a specified amount are paid to common stockholders.
Callable preferred stock is preferred stock that is redeemable at the option of the corporation.
Redeemable preferred stock is preferred stock that is redeemable at the option of the stockholder.

13. Capital Stock Issued for Cash
Goode Corporation issued 4,000 shares of $1 par common stock on April 1, 2005, for $45,000 cash.
Apr. 1 Cash 45,000
Common Stock 4,000
Paid-In Capital in
Excess of Par 41,000

14. Capital Stock Issued for Cash
On April 1, 2005, Goode Corporation issued 4,000 shares of no-par common stock without a stated value for $45,000 cash.
Apr. 1 Cash 45,000
Common Stock 45,000

15. Capital Stock Sold on Subscription
On November 1, 2005, a firm received subscriptions for 5,000 shares of $1 par common at $12.50 per share with 50% down, balance due in 60 days.
Nov. 1 Common Stock Subscription Receivable 62,500
Common Stock Subscribed 5,000
Paid-In Capital in Excess
of Par 57,500

16. Capital Stock Sold on Subscription
On November 1, 2005, a firm received subscriptions for 5,000 shares of $1 par common at $12.50 per share with 50% down, balance due in 60 days.
Nov. 1 Cash 31,250
Common Stock
Subscription Receivable 31,250

17. Capital Stock Sold on Subscription
On December 9, received balance due on one-half of subscribers and issued stock to fully paid subscribers, 2,500 shares.
Dec. 9 Cash 15,625
Common Stock Subscription Receivable 15,625
9 Common stock Subscribed 2,500
Common Stock 2,500

18. Stock Issued for Consideration Other Than Cash
AC Company issues 200 shares of $0.50 par value common stock in return for land. The company’s stock is currently selling for $50 per share.
Dec. 5 Land 10,000
Common Stock Paid-In Capital in Excess
of Par 9,900

19. Stock Issued for Consideration Other Than Cash
Assume that the land has a readily determinable market price of $12,000, but AC Company’s common stock has no established fair market value.
Dec. 5 Land 12,000
Common Stock Paid-In Capital in Excess
of Par 11,900

20. Companies acquired their own stock to…
Stock Repurchases
Companies acquired their own stock to…
Provide shares for incentive compensation and employee savings plans.
2. Obtain shares needed to satisfy requests by holders of convertible securities.
Reduce the amount of equity relative to the amount of debt.
Invest excess cash temporarily.
Remove some shares from the open market in order to protect against a hostile takeover.
6. Improve per-share earnings by reducing the number of shares outstanding and returning inefficiently used assets to shareholders.
7. Display confidence that the stock is currently undervalued by the market.

21. Treasury Stock
Stock issued by a corporation but subsequently reacquired by and held in the name of the corporation and held for possible future reissuance or retirement.
Reported as a contra-equity account, not as an asset.
Does not create a gain or loss on reacquisition, reissuance, or retirement.
May decrease Retained Earnings, but cannot increase it.
There are two methods to account for treasury stock transactions: (1) Cost method and (2) Par value method

22. Issued 10,000, $1 par value shares at $15 per share
Treasury Stock
Issued 10,000, $1 par value shares at $15 per share
Cost Method
Cash 150,000
Common Stock. 10,000
Paid-In Capital in
Excess of Par ,000
Par Value Method
Cash 150,000
Common Stock. 10,000
Paid-In Capital in
Excess of Par ,000

23. Reacquired 1,000 shares at $40 per share.
Treasury Stock
Reacquired 1,000 shares at $40 per share.
Cost Method
Treasury Stock 40,000
Cash 40,000
Par Value Method
Treasury Stock 1,000
Paid-In Capital in Excess of Par 14,000
Retained Earnings 25,000
Cash 40,000
The balance

24. Sold 200 shares of treasury stock at $50 per share.
Cost Method
Cash 10,000
Treasury Stock 8,000
Paid-In Capital from
Treasury Stock 2,000
Par Value Method
Cash 10,000
Treasury Stock 200
Paid-In Capital in Excess
of Par 9,800

25. Sold 500 shares of treasury stock at $34 per share.
Cost Method
Cash 17,000
Paid-In Capital from Treasury
Stock 2,000
Retained Earnings 1,000
Treasury Stock 20,000
Par Value Method
Cash 17,000
Treasury Stock 500
Paid-In Capital in Excess
of Par 16,500

26. Retired remaining 300 shares of treasury stock.
Cost Method
Common Stock 300
Paid-In Capital in Excess of Par 4,200
Retained Earnings 7,500
Treasury Stock 12,000
Par Value Method
Common Stock 300
Treasury Stock 300

27. Stock Rights, Warrants, and Options
Stock rights—Issued to existing shareholders to permit them to maintain their proportionate ownership interests when new shares are to be issued.
Stock warrants—Sold by the corporation for cash, generally in conjunction with the issuance of another security.
Stock options—Granted to officers or employees, usually as part of a compensation plan.

28. Stock Warrants
Stewart Co. sells 1,000 shares of $50 par preferred stock for $58 per share. Stewart Co. gives the purchaser detachable warrants enabling the holders to subscribe to 1,000 shares of $2 par common stock for $25 per share. Immediately following the issuance of the stock, the warrants are selling for $3, and the fair market value of a preferred share without the warrant attached is $57.

29. Stock Warrants = $3 $57 + $3 Value assigned to warrants
Total issue price
Market value of warrants x =
Market value of security without warrants
Market value of warrants +
$57 + $3
Value assigned to warrants =
$58,000 x $3
= $2,900

30. Stock Warrants
The entry on Stewart’s book to record the sale of the preferred stock with detachable warrants is:
Cash 58,000
Preferred Stock, $50 par 50,000 Paid-In Capital in Excess of
Par--Preferred Stock 5,100
Common Stock Warrants 2,900

31. Stock Warrants
If the warrants are exercised, the entry to record the issuance of common stock is:
Common Stock Warrants 2,900
Cash 25,000
Common Stock, $2 par 2,000 Paid-In Capital in Excess of
Par—Common Stock 25,900

32. Stock Warrants
If these warrants were allowed to expired, what entry would be required?
Common Stock Warrants 2,900
Paid-In Capital from
Expired Warrants 2,900

33. Stock-Based Compensation
On January 1, 2003, the board of directors of Neff Company authorize the grant of 10,000 stock options. Each option permits the purchase of one share of Neff common stock at $50 per share. The options vest or becomes exercisable on Jan 1, 2006.

34. Stock-Based Compensation
The company estimates a grant date value of $10 for each of the employee stock options. The total fair value of the options granted is $100,000. Compensation cost is allocated over three years from January 1, 2003 (the grant date) to January 1, 2006 (the vesting date).
On January 1, 2003, the board of directors of Neff Company authorize the grant of 10,000 stock options. Each option permits the purchase of one share of Neff common stock at $50 per share.

35. Stock-Based Compensation (Fair Value Method)*
Dec. 31 Compensation Expense 33,333
Paid-In Capital from
Stock Options 33,333
2003
$100,000 ÷ 3
Similar entries would be made in 2004 and 2005.
* There is also the Intrinsic Value Method, in which case these entries would not be made.

36. * Under the intrinsic value method, the entry would have been:
Stock-Based Compensation (Fair Value Method)*
On December 31, 2006, all 10,000 of the options are exercised to purchase Neff’s no-par common stock.
Dec. 31 Cash 500,000
Paid-In Capital from Stock
Options 100,000
Common Stock (no par) 600,000
2006
* Under the intrinsic value method, the entry would have been:
Dec. 31 Cash 500,000
Common Stock (no par) ,000
2006

37. * The entry would have been the same under the Intrinsic Value Method.
Stock-Based Compensation (Fair Value Method)*
If the options had been allowed to expired, the following entry would have been necessary on December 31, 2006:
Dec. 31 Paid-In Capital from Stock
Options 100,000
Paid-In Capital from
Expired Options 100,000
2006
* The entry would have been the same under the Intrinsic Value Method.

38. Stock Conversions Case 1
On December 31, 2005, 1,000 shares of preferred stock (par $50 and original selling price of $60) are exchanged for 4,000 shares of common stock (par $1)
Dec. 31 Preferred Stock, $50 par 50,000
Paid-In Capital in Excess of
Par—Preferred 10,000
Common Stock 4,000
Paid-In Capital in Excess
of Par—Common 56,000
2005

39. Stock Conversions Case 2
On December 31, 2005, 1,000 shares of preferred stock (par $50 and original selling price of $60) are exchanged for 4,000 shares of common stock (par $20)
Dec. 31 Preferred Stock, $50 par 50,000
Paid-In Capital in Excess of
Par—Preferred 10,000
Retained Earnings 20,000
Common Stock 80,000
2005

40. Accounting for Dividends
Declaration date: The date the corporation’s board of directors formally declares a dividend will be paid.
Date of record: The date on which stockholders of record are identified as those who will receive a dividend.
Date of payment: The date when the dividend is actually distributed to stockholders.

41. Cash Dividend
ABC Corporation declares a $100,000 dividend; the following journal entries should be made:
Declaration Date
Dividends (or Retained Earnings) 100,000
Dividends Payable 100,000
Payment Date
Dividends Payable 100,000
Cash 100,000

42. Property Dividend
It is a distribution to stockholders that is payable in some asset other than cash.

43. Property Dividend
Bigley Corporation owns 100,000 shares in Tri-State Oil Co, carrying value $2,700,000, current market value $3,000,000, or $30 per share. There are 1,000,000 shares of Bigley stock outstanding. A dividend of 1/10 of a share of Tri-State Oil Co. is declared for each share of Bigley stock outstanding.

44. Declaration of Dividend
Property Dividend
Declaration of Dividend
Dividend (or Retained Earnings) 3,000,000
Property Dividends Payable 2,700,000
Gain on Distribution of Property
Dividend 300,000
Payment of Dividend
Property Dividends Payable 2,700,000
Investment in Tri-State Oil Co. 2,700,000

45. Stock Dividends Small Less than 20-25% of the outstanding shares.
Debit Retained Earnings for the (post) MARKET value of the shares.
Large
Greater than 20-25% of the shares outstanding.
Debit Retained Earnings for the PAR value of the shares.

46. Example 1: Stock Dividend
Assume the following about Gean, Inc.:
Common stock ($2 par, 10,000
shares outstanding) $20,000
Additional paid-in capital $24,200
Retained earnings $12,500
Stock dividend declared 1,500 shares
Market price of stock $10/share
Is this a large or small stock dividend?..Because 1,500 shares represent 15% of the outstanding stock, it is a small stock dividend.

47. Example 1: Stock Dividend
Declaration Date
Retained Earnings 15,000
Stock Dividends Distributable 3,000
Paid-In Capital in Excess of Par 12,000
Issuance Date
Stock Dividends Distributable 3,000
Common Stock 3,000

48. Example 2: Stock Dividend
Assume the following about Gimli’s Corp.:
Common Stock ($5 par, 20,000
shares outstanding) $100,000
Additional Paid-In Capital $100,000
Retained Earnings $52,000
Stock Dividend Declared 10,000 shares
Market Price of Stock $20/share
50% = large dividend
Is this a large or small stock dividend?

49. Example 2: Stock Dividend
Declaration Date
Retained Earnings 50,000
Stock Dividends Distributable 50,000
Issuance Date
Stock Dividends Distributable 50,000
Common Stock 50,000

50. Unrealized Gains and Losses on Available-For-Sale Securities
Available-for-sale securities are those that were not purchased with the immediate intention to resell…
…but the company also doesn’t necessarily plan to hold these securities forever.

51. The impact of other income-related equity items
Kendell had net income of $1,350. Other items that impacted net income are:
Unrealized gain (loss) on available-
for-sale securities $100
(Increase) Decrease in minimum
pension liability (60 )
Unrealized gain (loss) on derivative
instruments (20 )
Foreign currency translation
adjustment, increase (decrease) in
stockholders’ equity 300

52. Unrealized Gains and Losses on Available-For-Sale Securities
Net income $1,350
Other comprehensive income:
Unrealized gain on available-for-
sale securities 60
Increase in minimum pension liability (36 )
Unrealized loss on derivative
instruments (12 )
Foreign current transaction
adjustments
Comprehensive income $1,542

53. Liquidating Dividend
A liquidating dividend is a distribution representing a return to stockholders of a portion of contributed capital.
See page 672 of text.

54. Disclosures Related to the Equity Section
Capital stock may be:
Authorized but unissued.
Subscribed for and held for issuance pending receipt of cash for the full amount of the subscription price.
Outstanding in the hands of stockholders.
Reacquired and held by the corporation for subsequent reissuance.
Canceled by appropriate corporate action.