1. Equity Financing

2. 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.
4. Account for the issuance of stock rights and stock warrants.

3. Learning Objectives
5. 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.

4. 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.

5. Learning Objectives EXPANDED MATERIAL
11. Eliminate a retained earnings deficit through a quasi-reorganization.
12. Use both the intrinsic value and fair value methods to account for performance-based stock option plans and plans calling for a cash settlement.

6. Components of Stockholders’ Equity
Retained
Earnings
Contributed
Capital
Other
Legal
Capital
Additional
Paid-In

7. Common Stock
The owners of common stock of a corporation can be thought of as the true owners of the business.

8. Common Stock
Unless restricted by terms of the articles of incorporation, the common stockholder has certain basic rights.

9. 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.

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

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

12. 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.

13. 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.

14. Issuance of Capital Stock
Goode Corporation issued 4,000 shares of $1 par common stock on April 1, 2002, for $45,000 cash.
Apr. 1 Cash 45,000
Common Stock 4,000
Paid-In Capital in
Excess of Par 41,000

15. Issuance of Capital Stock
Goode Corporation issued 4,000 shares of no-par common stock with a stated value of $1 on April1, 2002, for $45,000 cash.
Apr. 1 Cash 45,000
Common Stock 4,000
Paid-In Capital in
Excess of Stated
Value 41,000

16. Issuance of Capital Stock
On April 1, Goode Corporation issued 4,000 shares of no-par common stock without a stated value on April1, 2002, for $45,000 cash.
Apr. 1 Cash 45,000
Common Stock 45,000

17. Capital Stock Sold on Subscription
On November 1, 2002, 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
Common stock Subscribed 5,000
Paid-In Capital in Excess
of Par 57,500

18. 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
Common stock Subscribed 2,500
Common Stock 2,500

19. 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

20. 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

21. Stock Repurchases
To provide shares for incentive compensation and employee savings plans.
To obtain shares needed to satisfy requests by holders of convertible securities.
To reduce the amount of equity relative to the amount of debt.
To invest excess cash temporarily.
Why repurchase shares?

22. Stock Repurchases
To remove some shares from the open market in order to protect against a hostile takeover.
To improve per-share earnings by reducing the number of shares outstanding and returning inefficiently used assets to shareholders.
To display confidence that the stock is currently undervalued by the market.

23. Treasury Stock
Stock issued by a corporation but subsequently reacquired by 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.

24. Treasury Stock--Example: Both Accounting Methods
Issued 100, $10 par value shares at $15 per share
Cost Method
Cash 1,500
Common Stock. 1,000
Paid-In Capital in
Excess of Par
Par Value Method
Cash 1,500
Common Stock ,000
Paid-In Capital in
Excess of Par

25. Reacquired ten shares at $16 per share.
Treasury Stock--Example: Both Accounting Methods
Reacquired ten shares at $16 per share.
Cost Method
Treasury Stock 160
Cash
Par Value Method
Treasury Stock 100
Paid-In Capital in
Excess of Par 50
Retained Earnings 10
Cash 160

26. Sold two shares of treasury stock at $20 per share.
Treasury Stock--Example: Both Accounting Methods
Sold two shares of treasury stock at $20 per share.
Cost Method
Cash 40
Treasury Stock
Paid-In Capital
from Treasury
Stock 8
Par Value Method
Cash 40
Treasury Stock 20
Paid-In Capital in
Excess of Par 20

27. Sold five shares of treasury stock at $14 per share.
Treasury Stock--Example: Both Accounting Methods
Sold five shares of treasury stock at $14 per share.
Cost Method
Cash 70
Paid-In Capital from
Treasury Stock 8
Retained Earnings 2
Treasury Stock 80
Par Value Method
Cash 70
Treasury Stock 50
Paid-In Capital in
Excess of Par 20

28. Retired remaining three shares of stock.
Treasury Stock--Example: Both Accounting Methods
Retired remaining three shares of stock.
Cost Method
Common Stock 30
Paid-In Capital in
Excess of Par 15
Retained Earnings 3
Treasury Stock 48
Par Value Method
Common Stock 30
Treasury Stock 30

29. 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.

30. 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.

31. 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

32. 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

33. 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

34. Stock-Based Compensation
3434
Stock-Based Compensation
Yes No
All employees eligible? No
Compensatory Plan
Shares offered equally? No
Determine compensation
expense; amortize
over period employee
is to provide service.
Reasonable exercise period?
Grant and
Measurement
dates same?
Yes
Yes No No
Exercise Prices » Market Price?
Estimate compensation
expense; amortize
over period employee
is to provide service. No
Number of shares
and Exercise Price
known?
Non-compen-
satory Plan
Adapted from Jarnagin, Bill D. Financial Accounting Standards; Explanation and Analysis. 16 ed (CCH Inc., Chicago, Ill. 1994) pp
Yes
Record shares
issued when stock
is purchased.
Determine actual expense;
amortize over remaining
period employee is to
provide service.
Record shares issued
when stock is purchased.
Adjust for Unearned
Compensation, if any.

35. Factors Affecting Retained Earnings
Error corrections
Changes in accounting
principle
Net income
Quasi-reorganizations
Increases
Retained
Earnings

36. Factors Affecting Retained Earnings
Decreases
Changes in accounting
principles
Dividends
Error corrections
Prior period adjustments
Treasury stock
Net loss
Retained
Earnings

37. 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.

38. Cash Dividend
ABC Corporation declares a $2,000 dividend; the following journal entries should be made:
Declaration Date
Dividends (Retained Earnings) 2,000
Dividends Payable ,000
Payment Date
Dividends Payable 2,000
Cash ,000

39. What is a property dividend?

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

41. Property Dividend
XYZ Corporation declares a dividend of 1,000 shares of Gondor, Inc. stock (cost $3,000; fair market value, $5,000).
Date of Declaration
Dividend (or Retained Earnings) 5,000
Property Dividends Payable 3,000
Gain on Distribution of Property
Dividend 2,000

42. Entry on the Books of a 50% Shareholder
Property Dividend
Date of Payment
Property Dividends Payable 3,000
Investment in Gordor, Inc. Stock 3,000
Entry on the Books of a 50% Shareholder
Investment in Gordor, Inc. Stock 2,500
Dividend Revenue 2,500

43. Stock Dividends: Small or Large?
Less than 20-25% of the outstanding shares.
Debit Retained Earnings for the MARKET value of the shares.
Large
Greater than 20-25% of the shares outstanding.
Debit Retained Earnings for the PAR value of the shares.

44. 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
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?

45. Example 1: Stock Dividend
Because 1,500 shares represent 15% of the outstanding stock, it is a small 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

46. 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

47. 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?

48. 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

49. Liquidating Dividend
A liquidating dividend is a distribution representing a return to stockholders of a portion of contributed capital.

50. 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.

51. Quasi-Reorganization
Where state law permits, a company may eliminate a deficit through a restatement of invested capital balances. This provides a fresh start for the company with a zero balance in Retained Earnings.

52. Quasi-Reorganization
Balance Sheet for Anon., Inc.
Before Quasi-Reorganization
Current assets $ 250
Land, building, and equipment ,500
Accumulated depreciation (600)
Total assets …. $ 1,150
Liabilities $ 300
Common stock ($10 par, 100 shares) 1,000
Retained earnings (150)
Total liabilities and equity $ 1,150

53. Quasi-Reorganization
Quasi-Reorganization Plan for Anon., Inc.
Reduce land, building, and equipment to fair market value of $600.
Reduce par value of stock to $5; create $500 of “additional paid-in capital.”
Apply $450 deficit ($150 from Retained Earnings and $300 from fixed asset revaluation) against Paid-In Capital.

54. Quasi-Reorganization
Journal Entries for Anon., Inc.
Quasi-Reorganization
Fixed Asset Revaluation
Retained Earnings 300
Accumulated Depreciation 200
Land, Building, and Equipment 500

55. Quasi-Reorganization
Revalue Common Stock
Common Stock, $10 par 1,000
Common Stock, $5 par 500
Paid-In Capital from Stock
Revaluation 500
Erase Deficit
Paid-In Capital 450
Retained Earnings 450

56. Quasi-Reorganization
Balance Sheet
After Quasi-Reorganization
Current assets $ 250
Land, building, and equipment ,000
Accumulated depreciation (400)
Total assets $ 850
Liabilities $ 300
Common stock ($5 par, 100 shares)
Paid-in capital
Total liabilities and equity $ 850

57. The End