1. Financial Accounting: Tools for Business Decision Making, 4th Ed.
Kimmel, Weygandt, Kieso
CHAPTER 11
Prepared by
Ellen L. Sweatt
Georgia Perimeter College
and
Barbara Muller
Arizona State University West

2. REPORTING AND ANALYZING STOCKHOLDERS’ EQUITY
Chapter 11
REPORTING AND ANALYZING STOCKHOLDERS’ EQUITY

3. 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 the purchase of treasury stock.
Differentiate preferred stock from common stock.

4. Reporting and Analyzing Stockholders’ Equity
Prepare the entries for cash dividends and understand the effect of stock dividends and stock splits.
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 Created by law Legal entity
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.
Its stock is regularly traded on national securities markets.
Privately Held Corporation...
Usually has only a few stockholders and does not offer its stock for sale to general public.

7. Characteristics of a Corporation11 1
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

8. Separate Legal Existence
Separate and distinct from its 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.

9. Limited Liability of Stockholders
Creditors have recourse only to corporate assets to satisfy their claims.
Liability of stockholders limited to their investment in their corporation.
Creditors have no legal claim on personal assets of stockholders unless fraud has occurred.
Stockholders’ losses limited to amount of capital invested.

10. 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.

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

12. Continuous Life
Life of corporation is stated in its 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 a stockholder.

13. 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.

14. Corporate Organization Chart

16. Additional Taxes

17. 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.

18. 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 a stock certificate.

20. 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?

23. Authorized Stock... Issued Stock... Outstanding Stock...
Maximum amount of stock a corporation is allowed to sell as authorized by corporate charter.
Issued Stock...
Number of shares of issued stock have been sold and been paid for.
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. Par Value Stock...
Is capital stock that has been assigned a value per share in the corporate charter.
Legal capital per share must be retained in the business for the protection of corporate creditors.

26. Stated Value of No-Par Stock
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.

27. Stockholders’ Equity Section of a Corporation’s Balance Sheet
Two Parts:
Paid-in (contributed) capital - Amount paid to corporation by stockholders in exchange for shares of ownership.
Retained earnings (earned capital) - Earned capital held for future use in the business.

28. Review
Which of the following represents the maximum number of shares a corporation can issue?
Outstanding shares
Issued shares
Authorized Shares
Treasury Shares

29. Review
Which of the following represents the maximum number of shares a corporation can issue?
Outstanding shares
Issued shares
Authorized Shares
Treasury Shares

30. Accounting for Common Stock Issues11 2
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.

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

32. 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

33. Balance Sheet (partial)
Hydro-Slide, Inc.
Balance Sheet (partial)
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

34. Balance Sheet (partial) BEFORE TREASURY STOCK TRANSACTION
Mead, Inc.
Balance Sheet (partial)
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

35. Treasury Stock... 3 Is a corporation's own stock that has been issued11 3
Is a corporation's own stock
that has been issued
fully paid for
reacquired by the corporation
held in its treasury for future use.

36. 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.

37. Purchase of Treasury Stock
On February 1, 2007, Mead acquires ,000 shares of its stock at $8 per share.
Treasury Stock 32,000
Cash ,000

38. 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.

39. Balance Sheet (partial) AFTER TREASURY STOCK TRANSACTION
Mead, Inc.
Balance Sheet (partial)
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

40. Review
In the stockholders’ equity section, the cost of treasury stock is deducted from:
total paid-in capital and retained earnings
retained earnings
total stockholders’ equity
common stock in paid-in-capital

41. Review
In the stockholders’ equity section, the cost of treasury stock is deducted from:
total paid-in capital and retained earnings
retained earnings
total stockholders’ equity
common stock in paid-in-capital

42. 11 4
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.

43. 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.)

44. 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.

45. 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.

46. 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 obligation exists until a dividend is declared by the board of directors.
Must be disclosed in the notes to the financial statements.

47. 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

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

49. 11 5
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

50. Cash Dividend Is a pro rata distribution of cash to stockholders.
A corporation must have 3 things to pay cash dividends:
Retained earnings
Adequate cash
Declared dividends

51. Cash Dividend
In many states, payment of dividends from legal capital is prohibited.
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.

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

53. 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, 2007, 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

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

55. 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.

56. 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.

57. 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.

58. 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.

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

60. 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.

61. Review   
Vista, Inc. had 300,000 shares of common stock outstanding when a 30% stock dividend was declared and issued. How many shares were outstanding after the stock dividend?
390,000
330,000
300,000
309,000

62. Review   
Vista, Inc. had 300,000 shares of common stock outstanding when a 30% stock dividend was declared and issued. How many shares were outstanding after the stock dividend?
390,000
330,000
300,000
309,000

63. Retained Earnings... 6 Is net income that is retained in the business.11 6
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.

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

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

66. Stockholders’ Equity with Deficit

69. 11 8
The Payout Ratio =
CASH DIVIDENDS DECLARED ON COMMON STOCK
NET INCOME
… measures the percentage of earnings distributed in the form of cash dividends to common stockholders.

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

71. Advantages of Bond Financing Over Common Stock

72. Relationship of Par and No-Par Value to Legal Capital

73. 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

74. Review   
Roger is nearing retirement and would like to invest in a stock that will provide a good steady income supply. Roger should choose a stock with a:
a) high current ratio.
b) high dividend payout.
c) high earnings per share.
d) high price-earnings ratio.

75. Review   
Roger is nearing retirement and would like to invest in a stock that will provide a good steady income supply. Roger should choose a stock with a:
a) high current ratio.
b) high dividend payout.
c) high earnings per share.
d) high price-earnings ratio.