1. 11–1 Copyright © Cengage Learning. All rights reserved. Chapter 11 Management Issues Related to Contributed Capital

2. 11–2 Copyright © Cengage Learning. All rights reserved. What is Contributed Capital? Investments by stockholders, called contributed capital, is one of the major means of financing for a corporation

3. 11–3 Copyright © Cengage Learning. All rights reserved. What Is a Corporation? An entity having separate legal rights, privileges, and liabilities distinct from those of its owners. The result of a body of persons who have requested and been granted a charter by the state, recognizing the entity.

4. 11–4 Copyright © Cengage Learning. All rights reserved. Corporate Form of Business Separation of ownership and control Limited liability Double taxation More government regulation DisadvantagesAdvantages Centralized authority Professional management Continuous existence Lack of mutual agency Ease of transferring stock Ease of raising capital Separate legal entity Limited liability

5. 11–5 Copyright © Cengage Learning. All rights reserved. Using Equity Financing A stock certificate is issued to the owner Stockholder can transfer ownership at will Independent registrars and transfer agents are often used to keep track of stockholders’ records Stock Certificate Shows units of ownership in a corporation

6. 11–6 Copyright © Cengage Learning. All rights reserved. Par Value Usually bears little or no relationship to the market value or book value of shares Constitutes the legal capital of the corporation Legal capital –The number of shares issued times the par value –The minimum amount that can be reported as contributed capital An arbitrary amount assigned to each share of stock

7. 11–7 Copyright © Cengage Learning. All rights reserved. Initial Public Offering (IPO) May be used to act as intermediary between the corporation and investing public for an IPO Guarantees the sale of the stock for a fee The initial offering of capital stock Underwriter The corporation records the net proceeds of the offering

8. 11–8 Copyright © Cengage Learning. All rights reserved. Costs to Start a Corporation? Start-up and Organization Costs State incorporation fees Attorneys’ fees Cost of printing stock certificates Accountants’ fees related to registering the firm’s stock A corporation’s life normally is not known, so these costs are expensed as incurred.

9. 11–9 Copyright © Cengage Learning. All rights reserved. Dividends Distribution among stockholders of the assets that a corporation’s earnings have generated Stockholders receive these assets, usually cash, in proportion to the number of shares they own Board of directors has sole authority to declare dividends Decision to declare dividends affected by cash flows, pending lawsuits, economic situation, or debt levels.

10. 11–10 Copyright © Cengage Learning. All rights reserved. Dividend Dates Date of Declaration Board of directors formally declares that the corporation is going to pay a dividend

11. 11–11 Copyright © Cengage Learning. All rights reserved. Dividend Dates Date of Declaration Date of Record Board of directors formally declares that the corporation is going to pay a dividend Persons who own the stock on the record date will receive the dividend

12. 11–12 Copyright © Cengage Learning. All rights reserved. Dividend Dates Date of Declaration Date of Record Payment Date Board of directors formally declares that the corporation is going to pay a dividend Persons who own the stock on the record date will receive the dividend Date on which the dividend is paid to the stockholders of record

13. 11–13 Copyright © Cengage Learning. All rights reserved. Evaluating Dividend Policies Dividends Yield Ratio Tells investors how much they can expect to receive in dividends expressed as a percentage of the market price per share

14. 11–14 Copyright © Cengage Learning. All rights reserved. Return on Equity Most important ratio associated with stockholders’ equity Compensation of top executives often tied to return on equity

15. 11–15 Copyright © Cengage Learning. All rights reserved. Price/Earnings (P/E) Ratio A measure of investors’ confidence in a company’s future Because the market price is 16 times earnings, investors are paying a good price in relation to earnings. They do so in the expectation that this software company will continue to be successful Hwk E 3, Example Review problem pg 592-594

16. 11–16 Copyright © Cengage Learning. All rights reserved. Stock Option Plans Give employees the right to purchase stock in the future at a fixed price A means of both motivating and compensating employees On date of grant: estimate fair value of options Amount in excess of exercise price is recorded as compensation expense over the grant period

17. 11–17 Copyright © Cengage Learning. All rights reserved. Stockholders’ Equity Contributed capital Stockholders’ investments Retained earningsEarnings since corporation’s inception, less any losses, dividends, or transfers to contributed capital Treasury stockShares of its own stock that the corporation has bought back on the open market Three basic components:

18. 11–18 Copyright © Cengage Learning. All rights reserved. Contributed Capital Common StockPreferred Stock Basic form of stock that a corporation issues Also called residual equity, which means that if the corporation is liquidated, the claims of all creditors and usually those of preferred stockholders rank ahead of the claims of common stockholders Gives owners preference over common stockholders, usually in terms of receiving dividends and in terms of claims to assets if the corporation is liquidated Hwk E 5

19. 11–19 Copyright © Cengage Learning. All rights reserved. 11-19 Relationship of Shares

20. 11–20 Copyright © Cengage Learning. All rights reserved. Authorized, Issued, and Outstanding Shares Outstanding shares: Shares issued and still in circulation (unlike treasury stock) Issued shares: Sold or transferred to stockholders Authorized shares: Maximum number that the corporation’s charter allows it to issue

21. 11–21 Copyright © Cengage Learning. All rights reserved. What Are the Characteristics of Preferred Stock? One or more of the following: Preference as to dividends Convertibility Rights to assets on liquidation Callable option

22. 11–22 Copyright © Cengage Learning. All rights reserved. Dividend Preference Preferred stockholders must ordinarily receive a certain amount of dividends before common stockholders receive anything No guarantee of ever receiving dividends Consequences of not declaring an annual dividend depends on whether the preferred stock is cumulative or noncumulative Cumulative Dividend amount per share accumulates from year to year; Company must pay the whole amount before it pays any dividends on common stock Noncumulative Company is under no obligation to make up the missed dividend in future years

23. 11–23 Copyright © Cengage Learning. All rights reserved. A corporation has 20,000 shares of $100 par, 5 percent cumulative preferred stock, its first year of operations outstanding. If the corporation pays no dividends in 2011, its first year of operations, preferred dividends in arrears at the end of the year would amount to $100,000. (20,000 shares × $100 ×.05) Dividends in Arrears Dividends not paid to cumulative preferred stock in the year they are due If the corporation’s board declares dividends in 2012, the corporation must pay preferred stockholders the dividends in arrears plus their current year’s dividends before paying any dividends to common stockholders.

24. 11–24 Copyright © Cengage Learning. All rights reserved. January 1, 2011: A corporation issued 20,000 shares of $10 par, 6 percent cumulative preferred stock and 100,000 shares common stock. The board of directors declared a $6,000 dividend to preferred stockholders after the first year of operations. Dividends in Arrears Illustrated In 2012, the board of directors declared a $24,000 dividend to be distributed to preferred and common stockholders. How much of the $24,000 can be given to common stockholders and how much belongs to preferred stockholders?

25. 11–25 Copyright © Cengage Learning. All rights reserved. Dividends in Arrears Illustrated (cont’d) Record the journal entry for the declaration of the dividend: Hwk E 9-10; Example SE 6 & 7

26. 11–26 Copyright © Cengage Learning. All rights reserved. Convertible Preferred Stock Stockholder’s may exchange their shares of preferred stock for shares of common stock at a ratio stated in the company’s preferred stock contract

27. 11–27 Copyright © Cengage Learning. All rights reserved. A company issued 1,000 shares of 8 percent, $100 par value convertible preferred stock for $100 per share. Each share can be converted into 5 shares of the company’s common stock at any time. The market value of the common stock is now $15 per share and, in the past, the owner of common stock could expect dividends of $1 per share per year. At this point, the preferred stockholder receives more in dividends by keeping the preferred shares and is more likely to receive dividends than the common stockholders. Convertible Preferred Stock Illustrated

28. 11–28 Copyright © Cengage Learning. All rights reserved. A few years later, the dividends paid to common stockholders increase to $3 per share and market value is $30 per share. At this point, the market value of each share of convertible preferred stock is equivalent to $150 and converting to common would increase dividend payments from $8 per share to the equivalent of $15. Convertible Preferred Stock Illustrated (cont’d)

29. 11–29 Copyright © Cengage Learning. All rights reserved. Callable Preferred Stock Can be redeemed or retired at the option of the issuing corporation at a price stated in the preferred stock contract The call price is usually higher than the par value of the stock Reasons to call stock –A desire to pay lower dividends –Because the corporation has enough profits to retire preferred stock

30. 11–30 Copyright © Cengage Learning. All rights reserved. Issuance of Common Stock -Par Value Nocek Corporation is authorized to issue 10,000 shares of $10 par value common stock. The company issues 5,000 shares at $12 per share on January 1, 2010. Par value is the amount per share that is recorded in a corporation’s capital stock accounts

31. 11–31 Copyright © Cengage Learning. All rights reserved. Par Value Stock (continued) Balance Sheet Presentation Stockholders’ Equity Section

32. 11–32 Copyright © Cengage Learning. All rights reserved. No-Par Stock Nocek Corporation is authorized to issue 20,000 shares of no-par common stock. Suppose the company issues 5,000 shares at $15 per share on January 1, 2010. Assume Nocek’s board puts a $10 stated value on its no-par stock. It issues 5,000 shares at $15 per share on January 1, 2010. Stated value of stock can be any value set by the board unless the state specifies a minimum amount. Hwk E11; Example SE8

33. 11–33 Copyright © Cengage Learning. All rights reserved. Issuance of Stock for Noncash Assets Record the transaction at the fair market value of what the corporation is giving up (stock) If fair market value of the stock cannot be determined, use the fair market value of the assets or services received Board of directors has the right to determine the fair value of the property Companies may issue stock for services or assets like buildings or land

34. 11–34 Copyright © Cengage Learning. All rights reserved. When Nocek Corporation was formed on January 1, 2010, its attorney agreed to accept 200 shares of its $10 par value common stock for services rendered. At the time the stock was issued, its market value could not be determined. For similar services, the attorney would have billed $3,000. Issuance of Stock for Noncash Assets Hwk E12; Example SE9

35. 11–35 Copyright © Cengage Learning. All rights reserved. Treasury Stock Why do more than 67 percent of large companies repurchase their own stock? Use the stock for employee stock option plans Want to maintain a favorable market for their stock Want to increase earnings per share or stock price per share Want to have additional shares of stock available for purchasing other companies Attempt to prevent hostile takeovers

36. 11–36 Copyright © Cengage Learning. All rights reserved. On Sept. 15, Amber Corporation purchases 2,000 shares of its common stock on the market for $50 per share. When treasury stock is purchased, it is usually recorded at cost: Purchase of Treasury Stock Illustrated

37. 11–37 Copyright © Cengage Learning. All rights reserved. Balance Sheet Presentation Stockholders’ Equity Section Notice that the number of shares issued, and therefore legal capital, has not changed even though the number of shares outstanding has decreased. Purchase of Treasury Stock Illustrated (cont’d)

38. 11–38 Copyright © Cengage Learning. All rights reserved. Sale of Treasury Stock At costAbove cost Debit Cash Credit Treasury Stock, Common Debit Cash for proceeds Credit Treasury Stock, Common for cost Credit Paid-in Capital, Treasury Stock for amount over cost

39. 11–39 Copyright © Cengage Learning. All rights reserved. Dec. 15: Amber Corporation sells 1,200 shares of its treasury stock for $42 per share. (Cost was $50 per share.) When treasury shares are sold below cost, the difference is deducted from Paid-in Capital, Treasury Stock If the Paid-in Capital, Treasury Stock account cannot absorb the full amount of the difference, or doesn’t exist, Retained Earnings absorbs the remainder. Sale of Treasury Stock Below Cost

40. 11–40 Copyright © Cengage Learning. All rights reserved. Retirement of Treasury Stock Treasury stock is retired when the company determines that it will not reissue stock it has purchased If acquisition price < original contributed capital Credit Paid-In Capital, Retirement of Stock If acquisition price > original contributed capital Debit Retained Earnings Hwk E13-14; Example SE10-11