1. RICHARD G. SCHROEDER MYRTLE W. CLARK JACK M. CATHEY
FINANCIAL ACCOUNTING
THEORY AND ANALYSIS: TEXT AND CASES
11TH EDITION
RICHARD G. SCHROEDER
MYRTLE W. CLARK
JACK M. CATHEY 4

2. CHAPTER 15
EQUITY

3. Introduction Equity is risk capital
No guaranteed return
No repayment of the investment
The mix of debt and equity is called a company’s capital structure

4. Theories of Equity Proprietary Entity Fund Commander Enterprise
Residual equity

5. Definition of Equity SFAC No. 6 = residual interest
Definition of equity rests on definition of assets and liabilities
Assets – liabilities
Liabilities vs Equity
Liabilities require transfer of resources
Equity has no transfer requirement
FASB ASC
Requires that certain obligations that could be satisfied by issuance of equity securities be classified as liabilities

6. Distinction between Debt and Equity
FASB financial instruments project
Concerns about how to classify financial instruments in financial statements:
Financial instruments that have characteristics of liabilities, but are reported as equity or between liabilities and equity
Financial instruments that have characteristics of equity, but are presented between liabilities and equity
Financial instruments that have characteristics of both liabilities and equity, but are classified either as liabilities or equity.

7. Distinction between Debt and Equity
SFAS No. 150 (FASB ASC 480). limited its scope to three classes of freestanding financial instruments that embody obligations for the issuer:
Manditorily redeemable preferred stock unless the redemption is required to occur only upon liquidation or termination of the issuer,
Obligations to repurchase the issuer’s equity shares by transferring assets, and
Certain obligations to issue a variable number of shares.
The Board determined that financial instruments that fall into all three classes should be classified as liabilities

8. Reporting Equity Forms of business organization
Sole proprietorship
Partnership
Corporation
Most companies are sole proprietorships but the largest amount of business activity is carried out by corporations

9. Why? Limited liability Continuity Investment liquidity
Variety of ownership interests

10. Components of the Capital Section of a Corporation
OTHER COMPREHENSIVE INCOME
Paid-In Capital
Earned Capital

11. Paid-in Capital Common stock vs preferred stock
Features of preferred stock
Conversion
Call
Cumulative
Participating
Redemption
Paid-in Capital

12. Stock Options VS Compensatory Noncompensatory
When do you measure compensation in a compensatory plan?
APB Opinion No. 25

13. Recording Stock Options under FASB ASC 718
Many accountants believe that the provisions of APB No. 25 result in understated financial statement values
That is, the provisions of APB 25 seldom resulted in companies recording compensation expense when stock options were granted
Exposure draft
SFAS No 123 issued 1995
Encouraged recognition of estimated value of stock options as expense.
Recommended, but did not require fair value approach (Black-Scholes)
If APB Opinion No. 25 approach was used must show proforma net income and EPS effects

14. SFAS No. 123R (See FASB ASC 718)
Concern of deceptive accounting practices (e.g. Enron, Tyco and WorldCom).
Stock options used to avoid paying taxes
Requires companies to estimate compensation expense
Fair market value
Disclose estimated expense on Income Statement
Binomial lattice method
Opposition to provisions

15. Stock Warrants
Types
Valuation
The equity-liability question

16. Retained Earnings Accumulated net profits
Have not been distributed as dividends
May be divided into appropriated and unappropriated

17. Other Stockholders’ Equity Issues
Stock dividends vs. stock splits
Treasury stock
Other comprehensive income
Quasi reorganizations

18. Financial Analysis of Stockholders’ Equity
Return on common shareholders’ equity (ROCSE)
Reports on a company’s performance from the point of view of its common stockholders
Based on proprietary theory
Borrowing costs are considered expenses rather than a return on investment
Net income available to common shareholders
Average common stockholders’ equity

19. Return on Common Stockholders’ Equity

20. Financial Analysis of Stockholders’ Equity
Financial structure ratio (FSR)
Proportion of the company’s assets that are being financed by the stockholders
Average assets
Average common stockholders’ equity

21. Financial Structure Ratio

22. International Accounting Standards
“Framework for the Preparation of Financial Statements” indicated a preference for the proprietary theory.
Also indicated that equity may be sub classified into:
Contributed capital
Retained earnings
Capital maintenance adjustments

23. IFRS No. 2: Share-Based Payment
Specify financial reporting by entity for effects of share-based payment transactions
Broader than concept of employee share options
Measurement principles and specific requirements for 3 types of share-based payment transactions:
Equity-settled share-based payment transactions
Cash-settled share-based payment transactions
Transactions involving receipt of goods or services

24. Prepared by Kathryn Yarbrough, MBA
End of Chapter 15
Prepared by Kathryn Yarbrough, MBA
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