2. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 9A-1 CHAPTER 9 Measuring and Reporting Stockholders’ Equity PART A

3. 9A-2 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren CHARACTERISTICS OF A CORPORATION Separate legal entity –A corporation is a distinct legal entity formed under state law that exists apart from its owners, who are called stockholders or shareholders –The state grants a charter, which is a document that gives a business the state’s permission to form a corporation –The owners’ equity of a corporation is divided into shares of stock

4. 9A-3 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren CHARACTERISTICS OF A CORPORATION Continuous life and transferability of ownership –Corporations have continuous lives regardless of changes in the ownership of their stock –The transfer of the stock does not affect the continuity of the corporation

5. 9A-4 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren No mutual agency –Mutual agency is an arrangement whereby all owners act as agents of the business –A stockholder of a corporation cannot commit the corporation to a contract unless he or she is also an officer in the business CHARACTERISTICS OF A CORPORATION

6. 9A-5 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Limited liability of stockholders –Stockholders have no personal obligation for corporation liabilities –The most that a stockholder can lose on an investment in a corporation’s stock is the cost of the investment CHARACTERISTICS OF A CORPORATION

7. 9A-6 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Separation of ownership and management –A board of directors--elected by the stockholders--appoints officers to manage the business –Accounting provides information to help the stockholders evaluate their managers’ performance CHARACTERISTICS OF A CORPORATION

8. 9A-7 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Corporate taxation –Corporations are separate taxable entities –Corporate earnings are subject to double taxation of their income Corporations pay income taxes on their corporate income Stockholders pay personal income tax on the cash dividends (distributions) that they receive from corporations CHARACTERISTICS OF A CORPORATION

9. 9A-8 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Government regulation –Government regulation ensures that corporations disclose the information that investors and creditors need to make informed decisions The following slide summarizes the advantages and disadvantages of the corporate form of business organization CHARACTERISTICS OF A CORPORATION

10. 9A-9 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Can raise more capital than a proprietorship or partnership Continuous life Ease of transferring ownership No mutual agency of stockholders Limited liability of stockholders Separation of ownership Corporate taxation Government regulation Advantages and Disadvantages of a Corporation Advantages Disadvantages

11. 9A-10 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren ORGANIZATION OF A CORPORATION The process of creating a corporation begins when its organizers, called the incorporators, obtain a charter from the state The charter includes the authorization for the corporation to issue a certain number of shares of stock

12. 9A-11 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren The incorporators agree to a set of bylaws, which act as the constitution for governing the corporation The stockholders elect the members of the board of directors, which sets policy for the corporation and appoints the officers ORGANIZATION OF A CORPORATION

13. 9A-12 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren The board elects a chairperson, who usually is the most powerful person in the corporation The board designates the president, who is the chief operating officer in charge of day-to-day operations ORGANIZATION OF A CORPORATION

14. 9A-13 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Board of Directors Stockholders Chairperson of the Board President Vice President, Manufacturing Vice President, Sales Vice President, Accounting and Finance Vice President, Personnel Secretary Controller (Accounting Officer) Treasurer (Finance Officer) Authority Structure in a Corporation

15. 9A-14 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren STOCKHOLDERS’ RIGHTS Vote –Stockholders have the right to participate in management by voting on matters that come before them –A stockholder is entitled to one vote for each share of stock owned

16. 9A-15 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Dividends –The right to receive a proportionate share of any assets remaining after the corporation pays its liabilities in liquidation –Liquidation means to go out of business, sell the entity’s assets, pay its liabilities, and distribute any remaining cash to the owners STOCKHOLDERS’ RIGHTS

17. 9A-16 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren STOCKHOLDERS’ RIGHTS Preemption –The right to maintain one’s proportionate ownership in the corporation –The preemptive right is usually withheld for stockholders Shares

18. 9A-17 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren PAID-IN CAPITAL AND RETAINED EARNINGS Stockholders’ equity is divided into two main parts: –Paid-in capital (contributed capital) The amount of stockholders’ equity that the stockholders have contributed to the corporation –Retained earnings The amount of stockholders’ equity that the corporation has earned and not given back to the stockholders

19. 9A-18 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Because stock represents the corporation’s capital, it is often called capital stock –The basic unit of capital stock is called a share –The total number of authorized shares is limited by charter –Stock in the hands of a stockholder is said to be outstanding CAPITAL STOCK

20. 9A-19 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren CLASSES OF STOCK The stock of a corporation may be either –Common Stock The most basic form of capital stock issued by every corporation –Preferred Stock A class of stock that has several preferences over common stock

21. 9A-20 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Advantages of preferred stock: –Preferred stockholders receive dividends before common stockholders –Preferred stockholders receive assets before the common stockholders if the corporation liquidates CLASSES OF STOCK

22. 9A-21 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Preferred stock –Dividend payments are not tax deductible Dividends are not an expense Dividends are a distribution of assets created by earnings Most companies would rather borrow money and get a tax deduction for the interest expense –Does not usually carry the right to vote CLASSES OF STOCK

23. 9A-22 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Investment risk Corporate obligation to repay principal Dividends/interest Corporate obligation to pay dividends/interest Fluctuation in market value High No Dividends Only after declaration Medium High No Dividends Only after declaration MediumLow Yes Tax-deductible interest expense At fixed dates Low Common StockPreferred Stock Long-Term Debt Comparison of Common Stock, Preferred Stock, and Long-Term Debt

24. 9A-23 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Par value and no-par stock –Par value is an arbitrary amount assigned by a company to a share of its stock –Legal capital is The minimum amount of stockholders’ equity for the protection of creditors required by most states The par value of the shares issued CLASSES OF STOCK

25. 9A-24 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren No-par stock –Does not have a par value –Has a stated value, which makes it similar to par value stock CLASSES OF STOCK

26. 9A-25 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren ISSUING STOCK Corporations may –Sell the stock directly to the stockholder –Use the service of an underwriter An underwriter agrees to buy all the stock it cannot sell to its clients The stock that the corporation issues to stockholders is called issued stock The price the stockholder pays to acquire stock from the corporation is called the issue price

27. 9A-26 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Issuing Common Stock at Par Suppose IHOP’s common stock carries a par value of $10 per share. The stock issuance entry of 3.2 million shares at par value would be Jan. 8 Cash (3,200,000 x $10)32,000,000 Common Stock32,000,000 To issue common stock at par Jan. 8 Cash (3,200,000 x $10)32,000,000 Common Stock32,000,000 To issue common stock at par ISSUING STOCK

28. 9A-27 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Common stock issued for a price above par value creates a premium Both the par value of a stock and the premium are part of paid-in capital A company neither earns a profit nor incurs a loss when it sell its stock to, or buys its stock from, its own stockholders ISSUING STOCK

29. 9A-28 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Issuing Common Stock at a Price Above Par With a par value of $0.01, IHOP’s entry to record the issuance of the stock is: July 23 Cash (3,200,000 x $10) 32,000,000 Common Stock (3,200,000 x $0.01) 32,000 Paid-in Capital in Excess of Par--Common (3,200,000 x $9.99) 31,968,000 To issue common stock at a premium July 23 Cash (3,200,000 x $10) 32,000,000 Common Stock (3,200,000 x $0.01) 32,000 Paid-in Capital in Excess of Par--Common (3,200,000 x $9.99) 31,968,000 To issue common stock at a premium ISSUING STOCK

30. 9A-29 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Common stock, $0.01 par, 40 million shares authorized, 3.2 million shares issued $ 32,000 Paid-in capital in excess of par 31,968,000 Total paid-in capital32,000,000 Retained earnings26,000,000 Total stockholders’ equity $58,000,000 Stockholders’ Equity Assuming 40,000,000 shares of common stock authorized and retained earnings of $26,000,000, IHOP Corp. would report stockholders’ equity on its balance sheet as follows: ISSUING STOCK

31. 9A-30 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Issuing No-Par Common Stock When a company issues no-par stock, it debits the asset received and credits the stock account. Glenwood Corporation issues 3,000 shares of no-par common stock for $20 per share. The stock issuance entry is: Aug. 14 Cash (3,000 x $20)60,000 Common Stock 60,000 To issue no-par common stock Aug. 14 Cash (3,000 x $20)60,000 Common Stock 60,000 To issue no-par common stock There is no Paid-in Capital in Excess of Par for true no-par stock ISSUING STOCK

32. 9A-31 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Glenwood Corporation has $46,000 in retained earnings. The corporation reports stockholders’ equity on the balance sheet as follows: Common stock, no-par, 10,000 shares authorized, 3,000 shares issued$ 60,000 Retained earnings 46,000 Total stockholders’ equity$106,000 Stockholders’ Equity ISSUING STOCK

33. 9A-32 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Accounting for no-par stock with a stated value is identical to accounting for par value stock The premium account for no-par common stock with a stated value is entitled Paid-in Capital in Excess of Stated Value--Common Issuing No-Par Common Stock With a Stated Value ISSUING STOCK

34. 9A-33 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Issuing Common Stock for Assets Other Than Cash When a corporation issues stock in exchange for assets other than cash, it records the assets received at their current market value and credits the capital accounts accordingly. Kahn Corporation issued 15,000 shares of its $1 par common stock for equipment worth $4,000 and a building worth $120,000. Kahn’s entry is Nov. 12 Equipment 4,000 Building120,000 Common Stock (15,000 x $1) 15,000 Paid-in Capital in Excess of Par-- Common ($124,000 - $15,000) 109,000 To issue common stock in exchange for equipment and a building Nov. 12 Equipment 4,000 Building120,000 Common Stock (15,000 x $1) 15,000 Paid-in Capital in Excess of Par-- Common ($124,000 - $15,000) 109,000 To issue common stock in exchange for equipment and a building ISSUING STOCK

35. 9A-34 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Accounting for preferred stock follows the pattern illustrated for common stock Accounting for no-par preferred stock follows the pattern illustrated for no-par common stock Items are listed in the stockholders’ equity section of the balance sheet in the following order: preferred stock, common stock, and retained earnings Issuing Preferred Stock ISSUING STOCK

36. 9A-35 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren ETHICAL ISSUES Issuing stock for assets other than cash can pose an ethical challenge The company issuing the stock often wishes to record a large amount for the noncash asset received and for the stock that it is issuing –Large asset and stockholders’ equity amounts on the balance sheet make the business look more prosperous and more creditworthy

37. 9A-36 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren The ethical course of action is to record the asset at its current fair market value, as determined by a good-faith estimate of market value from independent appraisers ETHICAL ISSUES

38. 9A-37 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren TREASURY STOCK Treasury stock is a company’s own stock that it has issued and later reacquired The corporation holds the stock in its treasury

39. 9A-38 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Corporations may purchase their own stock for several reasons –The company has issued all its authorized stock and needs the stock for distributions to employees under stock purchase plans –The purchase helps support the stock’s market price by decreasing the supply of stock available to the public TREASURY STOCK

40. 9A-39 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren –The business is trying to increase net assets by buying its shares low and hoping to sell them for a higher price later –Management wants to avoid a takeover by an outside party The purchase of treasury stock decreases the company’s assets and its stockholders’ equity TREASURY STOCK A = L + SE

41. 9A-40 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren The purchase of treasury stock is recorded by debiting Treasury Stock and crediting the asset given in exchange--usually cash. Suppose that Jupiter Drilling Company had the following stockholders’ equity before purchasing treasury stock: Common stock, $1 par, 10,000 shares authorized, 8,000 shares issued$ 8,000 Paid-in capital in excess of par--common 12,000 Retained earnings 14,600 Total stockholders’ equity$34,600 Stockholders’ Equity (Before Purchase of Treasury Stock) TREASURY STOCK

42. 9A-41 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren On November 22, Jupiter purchases 1,000 shares of its $1 par common as treasury stock, paying cash of $7.50 per share. Jupiter records the purchase of treasury stock as follows: Nov. 22 Treasury Stock, Common (1,000 x $7.50) 7,500 Cash 7,500 Purchased 1,000 shares of treasury stock at $7.50 per share Nov. 22 Treasury Stock, Common (1,000 x $7.50) 7,500 Cash 7,500 Purchased 1,000 shares of treasury stock at $7.50 per share TREASURY STOCK Treasury Stock is a contra stockholders’ equity account

43. 9A-42 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren The treasury stock account has a debit balance Treasury stock is recorded at cost, without reference to the stock’s par value TREASURY STOCK

44. 9A-43 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Common stock, $1 par, 10,000 shares authorized, 8,000 shares issued, 7000 shares outstanding$ 8,000 Paid-in capital in excess of par--common 12,000 Retained earnings 14,600 Subtotal 34,600 Less treasury stock, 1,000 shares at cost (7,500) Total stockholders’ equity$27,100 Stockholders’ Equity (After Purchase of Treasury Stock) TREASURY STOCK Total stockholders’ equity decreases by the cost of the treasury stock

45. 9A-44 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren TREASURY STOCK Shares of outstanding stock decrease with the purchase of treasury stock Number of shares issued 8,000 Less number of shares of treasury stock(1,000) Number of shares outstanding 7,000 Number of shares issued 8,000 Less number of shares of treasury stock(1,000) Number of shares outstanding 7,000

46. 9A-45 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren TREASURY STOCK Sale of treasury stock at cost –If the stock is sold for the same price that the corporation paid to reacquire it, the entry is a debit to Cash and a credit to Treasury Stock for the same amount Sale of Treasury Stock

47. 9A-46 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Sale of treasury stock above cost –If the sale price of treasury stock is greater than its reacquisition cost, the difference is credited to the account Paid-in Capital from Treasury Stock Transactions because the excess came from the company’s stockholders Paid-in Capital from Treasury Stock Transactions is reported with other paid- in capital accounts on the balance sheet TREASURY STOCK

48. 9A-47 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren TREASURY STOCK Suppose Jupiter Drilling Company resold its treasury shares for $9 per share (cost was $7.50 per share). The entry is: Dec. 7 Cash (1,000 x $9)9,000 Treasury Stock, Common 7,500 Paid-in Capital from Treasury Stock Transactions1,500 To sell treasury stock at $9 per share Dec. 7 Cash (1,000 x $9)9,000 Treasury Stock, Common 7,500 Paid-in Capital from Treasury Stock Transactions1,500 To sell treasury stock at $9 per share

49. 9A-48 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Sale of treasury stock below cost –If treasury stock is sold below cost, the difference between these two amounts is debited to Paid-in Capital from Treasury Stock Transactions if this account has a credit balance –If this account’s balance is too small, then the company debits Retained Earnings for the remaining amount TREASURY STOCK

50. 9A-49 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Neither the purchase nor the sale of treasury stock creates a gain or loss for the income statement, and thus treasury stock transactions have no effect on net income The next slide illustrates a sequence of assumed treasury stock transactions for Eastman Kodak Company TREASURY STOCK

51. 9A-50 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren Assets $17 Assets $17 Liabilities $10 Liabilities $10 Stockholders’ Equity $7 Stockholders’ Equity $7 Assets $13 Assets $13 Liabilities $10 Liabilities $10 Assets $20 Assets $20 Liabilities $10 Liabilities $10 Before the purchase of its own stock After the purchase of treasury stock for $4 billion, Eastman Kodak is smaller After the resale of treasury stock for $7 billion, Eastman Kodak is larger Eastman Kodak Effects of a Purchase and Resale of Treasury Stock (amounts in billions) Effects of a Purchase and Resale of Treasury Stock (amounts in billions) Stockholders’ Equity $3 Stockholders’ Equity $3 Stockholders’ Equity $10 Stockholders’ Equity $10

52. 9A-51 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren END OF CHAPTER 9 PART A