1. Chapter 11, Slide #1 Using Financial Accounting Information: The Alternative to Debits and Credits Fifth Edition Gary A. Porter and Curtis L. Norton Copyright © 2008 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

2. Chapter 11, Slide #2 Disadvantages Advantages Advantages of Stock vs. Debt Financing  Flexibility  Exchanges facilitates trading  Return on investment

3. Chapter 11, Slide #3 Disadvantages of Stock vs. Debt Financing  Control  Tax consequences  Impact on ratios Disadvantages Advantages

4. Chapter 11, Slide #4 Expanded Accounting Equation Assets = Liabilities + Owners’ Equity Assets = Liabilities + Stockholders’ Equity Contributed Capital Retained Earnings

5. Chapter 11, Slide #5 Retained Earnings Connects the Income Statement and the Balance Sheet Statement of Retained Earnings Retained Earnings, Beginning Balance$ xxx Add: Net Income inc Deduct: Dividends xxx Retained Earnings, Ending Balance $ end Balance Sheet Total Assets $ xxx Total Liabilities xxx Stockholders’ Equity xxx Retained Earnings end Total Liabilities and Stockholders' Equity $ xxx Income Statement Revenues$ xxx Less: Expenses xxx Net Income$ inc

6. Chapter 11, Slide #6 Stockholders’ Equity Components LO1 Common Stock Preferred Stock Additional Paid-in Capital Retained Earnings Treasury Stock

7. Chapter 11, Slide #7 Contributed Capital  Common Stock Basic stock of corporation Normally carries voting rights  Preferred Stock Optional Tailored to meet specific needs

8. Chapter 11, Slide #8 Outstanding: not repurchased or retired Issued: sold or distributed Number of Shares of Stock Authorized Maximum Allowable

9. Chapter 11, Slide #9 Par Value  “Legal capital”  Arbitrary amount stated on stock certificate  Also called “stated value” Example: Certificate of Stock $1 par value

10. Chapter 11, Slide #10 Additional Paid-in Capital  Amount received in excess of par when stock was issued Example: Purchase a $1 par value share of stock for $15

11. Chapter 11, Slide #11 Retained Earnings  Net income retained in the business (not paid out as dividends) since its inception  Reinvested in a variety of assets (not necessarily liquid)

12. Chapter 11, Slide #12 Preferred Stock  Can tailor to specific needs of firm  Stated dividend rate Percentage of the stock’s par value Per-share amount  Often carries dividend preference over common stock LO2

13. Chapter 11, Slide #13 Preferred Stock Features  Callable  Convertible  Cumulative  Participating

14. Chapter 11, Slide #14 Stock Issued for Cash Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Cash Common Stock 10,000 15,000 Additional Paid-In Capital— Common 5,000 To record the issuance of 1,000 shares of $10 common stock at $15 per share. LO3 1,000 shares of $10 par value stock sold for $15 per share Common Stock $ 10,000 ( $10 par value × 1,000 shares) Additional Paid-In Capital $5,000 (($15 – $10) × 1,000 shares) Example:

15. Chapter 11, Slide #15 Stock Issued for Noncash Consideration  Record at fair market value of consideration given or received, whichever is more readily determinable Example: Exchange shares of stock for title to land, building, etc.

16. Chapter 11, Slide #16 Treasury Stock  Company buys back its own stock  Contra-equity account (debit balance)  Not outstanding (no voting rights) LO4

17. Chapter 11, Slide #17 Reasons for Repurchasing Stock  Provide for employee bonuses or benefit plans  Maintain a favorable market price  Improve financial ratios  Maintain control of ownership  Prevent unwanted takeover or buyout attempts

18. Chapter 11, Slide #18 Presentation of Treasury Stock Common stock, $10 par value, 1,000 shares issued, 900 outstanding $10,000 Additional paid-in capital—Common 12,000 Retained earnings 15,000 Total contributed capital and retained earnings 37,000 Less: Treasury stock, 100 shares at cost ($25 per share) 2,500 Total stockholders’ equity$34,500

19. Chapter 11, Slide #19 Cash Dividends  Dividends Paid on Date of Declaration  to Stockholders on Date of Record  on Payment Date

20. Chapter 11, Slide #20 Dividend Requirements  Sufficient cash  Positive retained earnings

21. Chapter 11, Slide #21 Dividend Payout Ratio Annual Dividend Amount Annual Net Income The % of earnings paid as dividends Dividend check for Date Dept.. of Treasurer Jane Doe I.M. Treasurer

22. Chapter 11, Slide #22 Dividends Journal entry required to record: (1) dividends declared (2) dividends paid Reduce retained earnings 12/31/071/15/08 Pay dividends

23. Chapter 11, Slide #23 Recording Cash Dividends Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Dividends + Retained Earnings Payable To record the declaration of a cash dividend. (Cash) = (Dividends Payable) To record the payment of a cash dividend. dividend check for Date Dept.. of Treasurer Jane Doe

24. Chapter 11, Slide #24 Allocation of Cash Dividends 1.Distribute dividends in arrears, if any, to preferred 2.Distribute current year’s dividends to preferred 3.Distribute remainder to common (or to both if preferred is participating) LO5

25. Chapter 11, Slide #25 Cash Dividends Example Stricker Company declares a $70,000 dividend in 2007 (no dividends were paid in 2005 or 2006). There are 10,000 shares of $10 par, 8% preferred stock and 40,000 shares of $5 par common stock outstanding.

26. Chapter 11, Slide #26 Cash Dividends Example To Preferred To Common Step 1: Distribute current-year dividend to preferred (10,000 shares × $10 par × 8% × 1 year) $8,000 Step 2: Distribute remaining dividend to common ($70,000 – $8,000) $62,000 Total allocated $8,000 $62,000 Noncumulative Preferred Stock $0.80 per share $1.55 per share

27. Chapter 11, Slide #27 Cash Dividends Example To Preferred To Common Step 1: Distribute dividends in arrears to preferred (10,000 shares × $10 par × 8% × 2 years) $16,000 Step 2: Distribute current-year dividend to preferred (10,000 shares × $10 par × 8% × 1 year) 8,000 Step 3: Distribute remainder to common ($70,000 – $8,000) $46,000 Total allocated $24,000 $46,000 Cumulative Preferred Stock $0.80 per share $1.55 per share

28. Chapter 11, Slide #28 Stock Dividends  Reasons: Insufficient cash Market price reduction Nontaxable to recipients  Issue of additional shares proportionately to existing stockholders LO6

29. Chapter 11, Slide #29 Stockholders’ Equity: Common stock, $10 par, 5,000 shares issued and outstanding $ 50,000 Additional paid-in capital—Common 30,000 Retained earnings 70,000 Total stockholders’ equity $150,000 Assume Shah Company declares a 10% stock dividend; 500 shares @ $40 per share market value Before Dividend Small Stock Dividend Example

30. Chapter 11, Slide #30 Stockholders’ Equity: Common stock, $10 par, 5,500 shares $ 50,000 $ 55,000 Additional paid-in capital—Common 30,000 45,000 Retained earnings 70,000 50,000 Total stockholders’ equity$150,000 $150,000 $40 market value deducted from retained earnings; allocated between Common Stock (initially Common Stock Dividend Distributable) and Additional Paid-In Capital. Before After Small Stock Dividend Example + + –

31. Chapter 11, Slide #31 Stockholders’ Equity: Common stock, $10 par, 5,500 shares $ 50,000 $ 55,000 Additional paid-in capital—Common 30,000 45,000 Retained earnings 70,000 50,000 Total stockholders’ equity$150,000 $150,000 Before After Small Stock Dividend Example + + – Total S/E is unchanged

32. Chapter 11, Slide #32 Stockholders’ Equity: Common stock, $10 par, 5,000 shares issued and outstanding $ 50,000 Additional paid-in capital—Common 30,000 Retained earnings 70,000 Total stockholders’ equity $150,000 Assume Shah Company declares 100% stock dividend Before Dividend Large Stock Dividend Example

33. Chapter 11, Slide #33 Stockholders’ Equity: Common stock, $10 par, 10,000 shares$ 50,000 $100,000 Additional paid-in capital—Common 30,00030,000 Retained earnings 70,000 20,000 Total stockholders’ equity$150,000 $150,000 Dividend deducted from retained earnings and recorded in the Common Stock account at par. Additional Paid-In Capital account is unaffected. Before After Large Stock Dividend Example + –

34. Chapter 11, Slide #34 Stockholders’ Equity: Common stock, $10 par, 10,000 shares $ 50,000 $100,000 Additional paid-in capital—Common 30,000 30,000 Retained earnings 70,000 20,000 Total stockholders’ equity$150,000 $150,000 Before After Large Stock Dividend Example + – Total S/E is unchanged

35. Chapter 11, Slide #35 Stock Splits  Results in additional issuance of shares  Reduces par value per share  No change in Stockholders’ Equity accounts LO 7 Example: Split of one $3 par-value share for three $1 par-value shares.

36. Chapter 11, Slide #36 Stock Splits  Not recorded in accounts  Reduce market price per share and make the stock more accessible to a wider range of investors Disclose in notes

37. Chapter 11, Slide #37 Stockholders’ Equity: Common stock, $10 par, 5,000 shares issued and outstanding $ 50,000 Additional paid-in capital—Common 30,000 Retained earnings 70,000 Total stockholders’ equity $150,000 Assume Shah Company declares 2-for-1 stock split Before Split 2-for-1 Stock Split Example

38. Chapter 11, Slide #38 Stockholders’ Equity: Common stock, $5 par, 10,000 shares $ 50,000 $ 50,000 Additional paid-in capital—Common 30,000 30,000 Retained earnings 70,000 70,000 Total stockholders’ equity$150,000 $150,000 Before After 2-for-1 Stock Split Example All accounts are unchanged Only disclosures are affected

39. Chapter 11, Slide #39 Statement of Stockholders’ Equity  Explains all the reasons for the difference between the beginning and the ending balance of each of the accounts in the Stockholders’ Equity category of the balance sheet Statement of Retained Earnings Beginning retained earnings Add: Net earnings Subtract: Dividend(s) declared = Ending retained earnings LO8

40. Chapter 11, Slide #40 Income Statement For Year Ended December 31, 20XX Revenues xxx Expenses xxx Other gains and losses xxx Income before tax xxx Income tax expense xxx Net income xxx Statement of Comprehensive Income For Year Ended December 31, 20XX Net incomexxx Foreign currency translation adjustmentxxx Unrealized holding gains/lossesxxx Minimum pension liability adjustmentxxx Other comprehensive incomexxx Comprehensive incomexxx Comprehensive income – the total change in net assets from all sources except investments by or distributions to the owners

41. Chapter 11, Slide #41 Analyzing Owners’ Equity  Book value per share Rights that each share of common stock has to the net assets of corporation  Market value per share Price at which stock is currently selling LO9

42. Chapter 11, Slide #42 Book Value per Share  Amount per share of net assets to which the company’s common stockholders have the rights  Does not indicate the price that should be paid by those who want to buy or sell the stock on the stock exchange Total Stockholders’ Equity Number of Shares of Stock Outstanding

43. Chapter 11, Slide #43 Market Value per Share  The selling price of the stock as indicated by the most recent transactions  Usually stated in a 52-week high and low  More meaningful measure of the value of the stock than book value 52-week Daily High LowSymHighLow Last Change 68.1739.17GM43.342.0142.93 +0.48 (1.13%)

44. Stockholders’ Equity Items on the Statement of Cash Flows Operating Activities Net income xxx Investing Activities Financing Activities Issuance of stock + Retirement or repurchase of stock – Payment of dividends – LO10

45. Chapter 11, Slide #45 Appendix Accounting Tools: Unincorporated Businesses

46. Chapter 11, Slide #46 Sole Proprietorships  Not a separate legal entity so owner has unlimited liability  Must keep personal and business records separate  Business income is declared on the owner’s personal tax return and taxed at personal tax rate LO11

47. Chapter 11, Slide #47 Sole Proprietorships Balance Sheet Income Statement Assets = Liabilities + Stockholders’+ Revenues - Expenses Equity Equipment P. Tom, Drawing (6,000) (6,000) Owners’ drawing or withdrawal accounts are contra-equity accounts

48. Chapter 11, Slide #48 Sole Proprietorships  Drawing or withdrawal and income summary accounts are closed to the owner’s capital account  Owner’s Equity section of the balance sheet consists of the capital account: Beginning balance$ 0 Plus: Investments 10,000 Net Income 4,000 Less: Withdrawals (6,000) Ending balance $ 8,000

49. Chapter 11, Slide #49 Partnerships  Unlimited liability  Limited life – partnership agreements can and do end  Not taxed as a separate entity

50. Chapter 11, Slide #50 Partnerships Distribution of income:  Equal distribution  Stated ratio  Other allocation For example, based on salaries, interest on invested capital, and a stated ratio

51. Chapter 11, Slide #51 End of Chapter 11