2. Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Shareholders’ Equity 18 Insert Book Cover Picture

3. 18-2 Learning Objectives Describe the components of shareholders’ equity and explain how they are reported in a statement of shareholders’ equity.

4. 18-3 The Nature of Shareholders’ Equity Assets – Liabilities = Shareholders’ Equity Net Assets (Residual Interest)

5. 18-4 Sources of Shareholders’ Equity Shareholders’ Equity Paid-in Capital Retained Earnings Amounts earned by corporation Amounts invested by shareholders Accumulated Other Comprehensive Income Other gains and losses not included in net income

6. 18-5 The Corporate Organization Advantages:  Ease of raising capital.  Ease of ownership transfer.  Limited liability.  Continuous existence. Disadvantages:  Double taxation.  Government regulation. Advantages:  Ease of raising capital.  Ease of ownership transfer.  Limited liability.  Continuous existence. Disadvantages:  Double taxation.  Government regulation.

7. 18-6 Types of Corporations Not-for-profit corporations include hospitals, charities, and government agencies such as FDIC. Privately-held corporations whose shares are owned by only a few individuals. Publicly-held corporations whose shares are widely owned by the general public.

8. 18-7 Hybrid Organizations S Corporation  Limited liability protection of a corporation.  Maximum number of owners. Limited liability company  Limited liability protection of a corporation.  All owners may be involved in management without losing limited liability protection.  No limit on number of owners. Limited liability partnership  Owners are liable for their own actions but not entirely liable for actions of other partners. S Corporation  Limited liability protection of a corporation.  Maximum number of owners. Limited liability company  Limited liability protection of a corporation.  All owners may be involved in management without losing limited liability protection.  No limit on number of owners. Limited liability partnership  Owners are liable for their own actions but not entirely liable for actions of other partners. Double taxation avoided.

9. 18-8 Formation of a Corporation Number and classes of shares authorized. Composition of initial board of directors. Nature and location of business activities. Corporate Charter

10. 18-9 Formation of a Corporation Articles of incorporation are filed with the state. Board of directors elected by shareholders. Board of directors appoint officers. Shares of stock issued. State issues a corporate charter.

11. 18-10 Fundamental Share Rights Right to vote. Right to share in distribution of assets if company is liquidated. Right to share in profits when dividends are declared. Preemptive right to maintain percentage ownership.

12. 18-11 Authorized, Issued, and Outstanding Capital Stock Authorized Shares The maximum number of shares of capital stock that can be sold to the public is called the authorized number of shares.

13. 18-12 Issued shares are authorized shares of stock that have been sold. Unissued shares are authorized shares of stock that have never been sold. Authorized Shares Authorized, Issued, and Outstanding Capital Stock

14. 18-13 Unissued Shares Treasury Shares Outstanding Shares Treasury shares are issued shares that have been reacquired by the corporation. Issued Shares Outstanding shares are issued shares that are owned by shareholders. Authorized Shares Authorized, Issued, and Outstanding Capital Stock

15. 18-14 Unissued Shares Retired Shares Outstanding Shares Retired shares assume the same status as authorized but unissued shares. Outstanding shares are issued shares that are owned by stockholders. Authorized Shares Authorized, Issued, and Outstanding Capital Stock

16. 18-15 Capital Stock Par value stock  Designated dollar amount per share stated in the corporate charter.  Par value has no relationship to market value. Par value stock  Designated dollar amount per share stated in the corporate charter.  Par value has no relationship to market value. No-par stock  Dollar amount per share not designated in corporate charter.  Corporations can assign a stated value per share (treated as if par value). No-par stock  Dollar amount per share not designated in corporate charter.  Corporations can assign a stated value per share (treated as if par value).

17. 18-16 Legal capital is...  The portion of shareholders’ equity that must be contributed to the firm when stock is issued.  The amount of capital, required by state law, that must remain invested in the business.  Refers to par value, stated value, or full amount paid for no-par stock. Legal capital is...  The portion of shareholders’ equity that must be contributed to the firm when stock is issued.  The amount of capital, required by state law, that must remain invested in the business.  Refers to par value, stated value, or full amount paid for no-par stock. Capital Stock

18. 18-17 Types of Capital Stock CommonPreferred

19. 18-18 The basic voting stock of the corporation. Ranks after preferred stock for dividend and liquidation distribution. Dividends determined by the board of directors. The basic voting stock of the corporation. Ranks after preferred stock for dividend and liquidation distribution. Dividends determined by the board of directors. Common Stock

20. 18-19 Preferred Stock Dividend and liquidation preference over common stock. Generally does not have voting rights. Usually has a par or stated value. May be convertible, callable, and/or redeemable.

21. 18-20 Are usually stated as a percentage of the par or stated value. May be cumulative or noncumulative. May be partially participating, fully participating, or nonparticipating. Are usually stated as a percentage of the par or stated value. May be cumulative or noncumulative. May be partially participating, fully participating, or nonparticipating. Preferred Stock Dividends

22. 18-21 Preferred Stock Dividends Cumulative Unpaid dividends must be paid in full before any distributions to common stock. Dividends in arrears are not liabilities, but the per share and aggregate amounts must be disclosed.

23. 18-22 Learning Objectives Describe comprehensive income and its components.

24. 18-23 Comprehensive Income Comprehensive income includes four types of gains and losses that traditionally have been excluded from net income. Net holding gains (losses) on investments. Deferred gains (losses) from derivatives. Net unrecognized loss on pensions. Gains (losses) from foreign currency translations.

25. 18-24 Comprehensive Income Components of comprehensive income created during the reporting period: ($ in millions) Net income $xxx Other comprehensive income: Net unrealized holding gains (losses) on investments (net of tax)† $ x Net unrecognized loss on pensions (net of tax)‡ (x) Deferred gains (losses) from derivatives (net of tax)§ x Gains (losses) from foreign currency translation (net of tax)* x xx Comprehensive income $xxx †Changes in the market value of securities available-for-sale. ‡Reporting a pension liability sometimes requires recording this (described in Chapter 17). It often is called pension liability adjustment. §When a derivative designated as a cash flow hedge is adjusted to fair value, the gain or loss is deferred as a component of comprehensive income and included in earnings later, at the same time as earnings are affected by the hedged transaction (described in the Derivatives Appendix to the text). *Gains or losses from changes in foreign currency exchange rates. The amount could be an addition to or reduction in shareholders’ equity. (This item is discussed elsewhere in your accounting curriculum.)

26. 18-25 Comprehensive income is reported periodically as it is created and also is reported as a cumulative amount. Comprehensive Income There are 3 options for reporting comprehensive income created during the reporting period. The accumulated amount of comprehensive income is reported as a separate item of shareholders’ equity in the balance sheet. As a separate statement in a disclosure note. As an additional section of the income statement. As part of the statement of shareholders’ equity.

27. 18-26 Learning Objectives Record the issuance of shares when sold for cash, for noncash consideration, and by share purchase contract.

28. 18-27 Issuing Stock for Cash 10,000 shares of $1 par value stock is issued for $100,000 cash.

29. 18-28 Issuing Stock for Cash 10,000 shares of no-par stock is issued for $100,000 cash.

30. 18-29 Issuing Stock for Cash 10,000 shares of no-par stock, with a stated value of $1 is issued for $100,000 cash.

31. 18-30 Issuing Stock for Noncash Assets Apply the general valuation principle by using fair value of stock given up or fair value of asset received, whichever is more clearly evident. If market values cannot be determined, use appraised values. Apply the general valuation principle by using fair value of stock given up or fair value of asset received, whichever is more clearly evident. If market values cannot be determined, use appraised values.

32. 18-31 More Than One Security Issued for a Single Price  Allocate the lump-sum received based on the relative fair values of the two securities.  If only one fair value is known, allocate a portion of the lump-sum received based on that fair value and allocate the remainder to the other security.  Allocate the lump-sum received based on the relative fair values of the two securities.  If only one fair value is known, allocate a portion of the lump-sum received based on that fair value and allocate the remainder to the other security.

33. 18-32 Toys, Inc. issued 5,000 shares of common stock, $10 par value and 3,000 shares of preferred stock, $5 par value for $450,000. The market values of the common stock and preferred stock were $55 and $75, respectively. Calculate the additional paid-in capital for each class of stock. Toys, Inc. issued 5,000 shares of common stock, $10 par value and 3,000 shares of preferred stock, $5 par value for $450,000. The market values of the common stock and preferred stock were $55 and $75, respectively. Calculate the additional paid-in capital for each class of stock. More Than One Security Issued for a Single Price

34. 18-33 Record the journal entry for issuing the stock. More Than One Security Issued for a Single Price

35. 18-34 More Than One Security Issued for a Single Price

36. 18-35 Share Issue Costs Share issue costs reduce net proceeds from selling shares, resulting in a lower amount of additional paid-in capital.  Registration fees  Underwriter commissions  Printing and clerical costs  Legal and accounting fees  Promotional costs

37. 18-36 Share Purchase Contracts An agreement between a corporation and a subscriber whereby shares are sold in exchange for a promissory note. Dow Industrial sold 100,000 shares of its $1 par value stock for $10 using a share purchase contract. Forty percent of the sale price was collected at sale and sixty percent will be received in six months. Prepare the journal entry for this transaction. Dow Industrial sold 100,000 shares of its $1 par value stock for $10 using a share purchase contract. Forty percent of the sale price was collected at sale and sixty percent will be received in six months. Prepare the journal entry for this transaction.

38. 18-37 Share Purchase Contracts The receivable is not an asset. It is reported as reduction in paid-in capital.

39. 18-38 Let’s turn our attention to reacquiring shares.

40. 18-39 Share Buybacks A corporation might reacquire shares of its stock to...  Support the market price.  Increase earnings per share.  Distribute in stock option plans.  Issue as a stock dividend.  Use in mergers and acquisitions.  Thwart takeover attempts. A corporation might reacquire shares of its stock to...  Support the market price.  Increase earnings per share.  Distribute in stock option plans.  Issue as a stock dividend.  Use in mergers and acquisitions.  Thwart takeover attempts.

41. 18-40 I can account for the reacquired shares by retiring them or by holding them as treasury shares. Share Buybacks

42. 18-41 Learning Objectives Describe what occurs when shares are retired and how retirement is recorded.

43. 18-42 Accounting for Retired Shares When shares are formally retired, we reduce the same capital accounts that were increased when the shares were issued – common or preferred stock, and additional paid-in capital.

44. 18-43 5,000 shares of $2 par value stock that were issued for $20 per share are reacquired for $17 per share.  Price paid is less than issue price. Accounting for Retired Shares

45. 18-44  Price paid is more than issue price. 5,000 shares of $2 par value stock that were issued for $20 per share are reacquired for $25 per share. Accounting for Retired Shares Reduce Retained Earnings if the Paid-in Capital – Share Repurchase account balance is insufficient.

46. 18-45 Learning Objectives Distinguish between accounting for retired shares and for treasury shares.

47. 18-46 Treasury Stock Usually does not have:  Voting rights.  Dividend rights.  Preemptive rights.  Liquidation rights. Reduces both assets and shareholders’ equity.

48. 18-47 Acquisition of Treasury Stock  Recorded at cost to acquire. Resale of Treasury Stock  Treasury Stock credited for cost.  Difference between cost and issuance price is (generally) recorded in paid-in capital – share repurchase. Acquisition of Treasury Stock  Recorded at cost to acquire. Resale of Treasury Stock  Treasury Stock credited for cost.  Difference between cost and issuance price is (generally) recorded in paid-in capital – share repurchase. Accounting for Treasury Stock

49. 18-48 On 5/1/05, Photos-in-a-Second reacquired 3,000 shares of its common stock at $55 per share. On 12/3/06, Photos-in-a-Second reissued 1,000 shares of the stock at $75 per share. Which of the following would be included in the 12/3 entry? a. Credit Cash for $165,000. b. Debit Treasury Stock for $75,000. c. Credit Treasury Stock for $55,000. d. Credit Cash for $75,000. On 5/1/05, Photos-in-a-Second reacquired 3,000 shares of its common stock at $55 per share. On 12/3/06, Photos-in-a-Second reissued 1,000 shares of the stock at $75 per share. Which of the following would be included in the 12/3 entry? a. Credit Cash for $165,000. b. Debit Treasury Stock for $75,000. c. Credit Treasury Stock for $55,000. d. Credit Cash for $75,000. Accounting for Treasury Stock

50. 18-49 On 5/1/05, Photos-in-a-Second reacquired 3,000 shares of its common stock at $55 per share. On 12/3/06, Photos-in-a-Second reissued 1,000 shares of the stock at $75 per share. Which of the following would be included in the 12/3 entry? a. Credit Cash for $165,000. b. Debit Treasury Stock for $75,000. c. Credit Treasury Stock for $55,000. d. Credit Cash for $75,000. On 5/1/05, Photos-in-a-Second reacquired 3,000 shares of its common stock at $55 per share. On 12/3/06, Photos-in-a-Second reissued 1,000 shares of the stock at $75 per share. Which of the following would be included in the 12/3 entry? a. Credit Cash for $165,000. b. Debit Treasury Stock for $75,000. c. Credit Treasury Stock for $55,000. d. Credit Cash for $75,000. Solution Accounting for Treasury Stock

51. 18-50 Accounting for Treasury Stock

52. 18-51 Reporting Treasury Stock  Reported in Shareholders’ Equity.  Unallocated reduction of total Shareholders’ Equity.  Reported in Shareholders’ Equity.  Unallocated reduction of total Shareholders’ Equity.

53. 18-52 Learning Objectives Describe retained earnings and distinguish it from paid-in-capital.

54. 18-53 Retained Earnings Represents the undistributed earnings of the company since its inception.

55. 18-54 Retained Earnings  The statement of retained earnings may also contain the correction of an accounting error that occurred in the financial statements of a prior period, called a prior period adjustment.  Any restrictions on retained earnings must be disclosed in the notes to the financial statements.  The statement of retained earnings may also contain the correction of an accounting error that occurred in the financial statements of a prior period, called a prior period adjustment.  Any restrictions on retained earnings must be disclosed in the notes to the financial statements.

56. 18-55 Example: Shareholders’ Equity Section of a Balance Sheet

57. 18-56 Learning Objectives Explain the basis of corporate dividends, including the similarities and differences between cash and property dividends.

58. 18-57 Cash Dividends Dividends must be declared by the board of directors before they can be paid. When a dividend is declared, a liability is created. A corporation is not legally required to pay dividends. Cash dividends require sufficient cash and retained earnings to cover the dividend.

59. 18-58 Dividend Dates Declaration date  Board of directors declares the dividend.  Record a liability.

60. 18-59 Dividend Dates Ex-dividend date  The first day the shares trade without the right to receive the declared dividend. (No entry) July X

61. 18-60 Dividend Dates Date of record  Stockholders holding shares on this date will receive the dividend. (No entry) July XX

62. 18-61 Dividend Dates Date of payment  Record the payment of the dividend to stockholders.

63. 18-62 Property Dividends  Distributions of non- cash assets.  Record at fair value of non-cash asset.  Recognize gain or loss for difference between book value and fair value.  Distributions of non- cash assets.  Record at fair value of non-cash asset.  Recognize gain or loss for difference between book value and fair value.

64. 18-63 Learning Objectives Explain stock dividends and stock splits and how they are accounted for.

65. 18-64 Stock Dividends All shareholders receive the same percentage increase in shares. No change in total shareholders’ equity. Distribution of additional shares of stock to shareholders.

66. 18-65 Stock Dividends Reasons for stock dividends:  To preserve cash.  To decrease market price of stock.  To reduce existing balance in retained earnings.

67. 18-66 Record at current market value of stock. Stock dividend < 25% Stock Dividends Stock dividend 25% Record at par or stated value of stock. SmallLarge >

68. 18-67 Stock Dividends CarCo declares and distributes a 20% stock dividend on 5 million common shares. Par value is $1 and market value is $20. Prepare the required journal entry.

69. 18-68 Stock Dividends CarCo declares and distributes a 20% stock dividend on 5 million common shares. Par value is $1 and market value is $20. Prepare the required journal entry.

70. 18-69 Stock Splits  Decrease par value of stock.  Increase number of outstanding shares.  No change in total stockholders’ equity.  Does not require a journal entry. Ice Cream Parlor Banana Splits On Sale Now

71. 18-70 Accounting for Stock Splits A corporation had 5,000 shares of $1 par value common stock outstanding before a 2–for–1 stock split.

72. 18-71 Accounting for Stock Splits Increase Decrease No Change A corporation had 5,000 shares of $1 par value common stock outstanding before a 2–for–1 stock split.

73. 18-72 Stock Splits Effected in the Form of Large Stock Dividends Matrix, Inc. declares and distributes a 2-for-1 stock split effected in the form of a 100% stock dividend. The company has 1,000,000, $1 par value common stock outstanding. The stock is trading in the open market for $14 per share. The per share par value of the shares is not to be changed.

74. 18-73 Matrix, Inc. declares and distributes a 2-for-1 stock split effected in the form of a 100% stock dividend. The company has 1,000,000, $1 par value common stock outstanding. The stock is trading in the open market for $14 per share. The per share par value of the shares is not to be changed and the company will capitalize retained earnings. Stock Splits Effected in the Form of Large Stock Dividends

75. 18-74 Appendix 18 Quasi Reorganizations

76. 18-75 Quasi Reorganizations Purpose To allow a company undergoing financial difficulty, but with favorable future prospects, to get a fresh start by writing down inflated assets and eliminating an accumulated balance in retained earnings. Purpose To allow a company undergoing financial difficulty, but with favorable future prospects, to get a fresh start by writing down inflated assets and eliminating an accumulated balance in retained earnings.

77. 18-76 Procedures  The firm’s assets and liabilities are revalued to reflect market values, with corresponding debits and credits to retained earnings.  The debit balance in retained earnings is eliminated first against additional paid in capital, and then, if necessary, against common stock.  Retained earnings is dated to indicate when the new accumulation of earnings began. Procedures  The firm’s assets and liabilities are revalued to reflect market values, with corresponding debits and credits to retained earnings.  The debit balance in retained earnings is eliminated first against additional paid in capital, and then, if necessary, against common stock.  Retained earnings is dated to indicate when the new accumulation of earnings began. Quasi Reorganizations

78. 18-77 Emerson-Walsch Corporation has incurred losses for several years. The board of directors voted to implement a quasi reorganization, subject to shareholder approval. The balance sheet prior to restatement, in millions, follows : Emerson-Walsch Corporation has incurred losses for several years. The board of directors voted to implement a quasi reorganization, subject to shareholder approval. The balance sheet prior to restatement, in millions, follows : Quasi Reorganizations

79. 18-78 Let’s prepare the journal entries necessary for the quasi reorganization. Quasi Reorganizations Fair value of the inventory is $300,000,000 and fair value of the property, plant, and equipment is $225,000,000.

80. 18-79 To revalue assets. Quasi Reorganizations

81. 18-80 To eliminate the deficit in retained earnings Now, let’s prepare the balance sheet immediately after restatement. Quasi Reorganizations $300 + $250

82. 18-81 Quasi Reorganizations

83. 18-82 End of Chapter 18