1. Chapter 11: Stockholders’ Equity
1. Debt versus equity
2. Preferred stock
3. Common stock
4. Accounting for preferred and common stock
5. Treasury stock
6. Retained earnings and dividends
7. Statement of stockholders’ equity

2. 1. Debt versus Equity Debt Equity
Fixed maturity date No fixed maturity date
Fixed periodic payments Discretionary dividends
Security in case of default Residual asset interest
No voice in management Voting rights - common
Formal legal contract No legal contract
Interest expense deductible Dividends not deductible
Double taxation

3. 2. Preferred Stock Advantages Disadvantages Debt or equity?
Preference over common in liquidation
Stated dividend
Variety of features regarding dividends
Preference over common in dividend payout
Disadvantages
Subordinate to debt in liquidation
Stated dividend can be skipped
No voting rights (versus common)
Debt or equity?
components of both
usually (but not always) classified with equity

4. 3. Common Stock Advantages Disadvantages Voting rights:
election of board of directors
vote on significant activities of management
Rights to residual profits (after preferred)
Disadvantages
Last in liquidation
No guaranteed return

5. 4. Accounting for Common Stock (CS) and Preferred Stock (PS)
Par value - initially established to create a “minimum legal capital”.
Ex: Minimum legal capital in some states is $1,000 for new corporations, so issue:
1,000 shares at $1par, or
100 shares at $10 par, or other combination. . .
Par value is not market value.
Credit CS or PS for par value.
Excess over par credited to “Paid in Capital in Excess of Par or Stated Value” or abbreviated: “Additional Paid-in Capital” (APIC).
Some newer stock issues (for common stock) are “no par” stock.

6. 4. Journal Entries Issue PS at greater than par value:
Cash xx mkt. value
Preferred Stock xx total par
APIC - PS xx excess(plug)
Issue CS at greater than par value:
Common Stock xx total par
APIC - CS xx excess(plug)
Note: most states do not allow companies to issue at less than par value.

7. 4. Journal Entries -continued
Issue no par common stock:
Cash xx mkt. value
Common Stock xx mkt. value
Note: many companies have newer stock issues that are no par, but most companies still have older stock issues which contain a par value and APIC.
The Stockholders’ Equity section of the balance sheet of Sample Company (next slide) illustrates many of the components of SE discussed in this chapter.

8. 4.Sample Co. Stockholders’ Equity
Common stock, $1 par value, 500,000 shares
authorized, 80,000 shares issued, and
75,000 shares outstanding $ 80,000
Preferred stock, $100 par value, 1,000 shares
authorized, 100 shares issued and
outstanding ,000
Paid in capital on common $ 20,000
Paid in capital on preferred , ,000
Retained earnings ,000
Less: Treasury stock, 5,000 shares (at cost) (6,000)
Total Stockholders’ Equity $131,000

9. 4. Journal Entries-Sample Co.
Now, using Sample Company information, record the following additional issues of common and preferred stock:
Issued 100 shares of PS at $102 per share:
Cash (100x $102) 10,200
PS (100x $100 par) 10,000
APIC - PS (plug)
Issued 500 shares of CS at $5 per share:
Cash (500 x $5) 2,500
CS (500 x $1 par)
APIC - CS (plug) 2,000

10. 5. Treasury Stock
Created when a company buys back shares of its own common stock.
Reasons for buyback:
reissue to employees for compensation.
hold in treasury (or retire) to increase market price and earnings per share.
reduce total dividend payouts while maintaining per share payouts.
thwart takeover attempts by reducing proportion of shares available for purchase.
give cash back to existing shareholders.

11. 5. Treasury Stock - continued
The debit balance account called “Treasury Stock” is reported in stockholders’ equity as a contra (reduces SE). Note: not an asset.
The stock remains issued, but is no longer outstanding.
does not have voting rights
cannot receive cash dividends
May be reissued (to the market or to employees) or retired.
No gains or losses are ever recognized from these equity transactions.

12. 5. Treasury Stock(TS) - Journal Entries
There are two techniques for recording TS transactions (Par Value method and Cost method). We will use only the Cost method. This technique establishes a “cost” for TS equal to the amount paid to acquire the TS. Par value is not used for TS transactions.
To record purchase of TS from market:
TS xx “cost”
Cash xx market
(cost equals the cash paid)

13. 5. Treasury Stock(TS) - Journal Entries
To reissue TS to market at greater than cost:
Cash xx market
APIC - TS xx over cost
TS xx cost
To reissue TS to market at less than cost:
Cash xx market
APIC - TS xx if available
Retained Earnings xx if needed*
TS xx cost
*debit RE if no APIC-TS available to absorb the remaining debit difference.

14. 5. TS - Example Problem
TT Corporation has 100,000 shares of $1 par value stock authorized, issued and outstanding at January 1, The stock had been issued at an average market price of $5 per share, and there have been no treasury stock transactions to this point.
Assume that, in February of 2008, TT Corp. repurchases 10,000 shares of its own stock at $7 per share. In July of 2008, TT Corp. reissues 2,000 shares of the treasury stock for $8 per share. In December of 2008, TT Corp. reissues the remaining 8,000 shares for $6 per share. Prepare the journal entries for 2008 regarding the treasury stock.

15. 5. TS Example -Journal Entries
Feb: repurchase 10,000 $7 = $70,000.
July: reissue 2,000 $ 8 = $16,000
(cost = $7 = 14,000)

16. 5. TS Example -Journal Entries
Dec: reissue 8,000 $ 6 = $48,000
(cost = 8,000 $7 = 56,000)
Now we need to debit one or more accounts to compensate for the difference.
(1) debit APIC-TS (but lower limit is to -0-).
(2) debit RE if necessary for any remaining balance (this is only necessary when we are decreasing equity).

17. 6. Retained Earnings - Cash Dividends
As cash dividends are declared:
Dividends (RE) - common xx
Dividends (RE)- preferred xx
Dividends Payable xx
As cash dividends are paid:
Dividends Payable xx
Cash xx
Preferred dividends may be issued with extra privileges such as “cumulative” and “participating.
Cumulative preferred dividends that are skipped in a particular year must be settled before any dividends are paid to common shares.
Participating preferred stock may receive a cash dividend in excess of its stated amount.

18. 6. RE - Stock Dividends
Stock dividends are distribution of additional shares of a company’s own stock to its shareholders. Note that the distribution of additional shares does not result in any value being given to the shareholders.
Example: 4 shareholders, each having 10 shares of common stock. Each owner has 25% of total (10/40). If I give each shareholder 1 additional share of stock, each shareholder still owns 25% of the same company (11/44). Nothing has changed, except the number of the pieces of paper.

19. 6. RE - Stock Dividends
Large stock dividends (> 25% of the outstanding common shares) are recorded at par value.
As stock dividends are declared:
Stock Dividends (RE) xx par Stock Div. Distributable xx par
As stock dividends are distributed:
Stock Div. Distributable xx par
Common Stock xx par
Note that Stock Dividends Distributable is not a liability, it is another equity account (see Sample Company) which indicates that there are additional shares of stock that will be issued but are not currently outstanding.

20. 6. RE - Stock Dividends
Analyze the effect of the transactions on the balance sheet:
Stock Dividends (RE) xx SE Stock Div. Distributable xx +SE
As stock dividends are distributed:
Stock Div. Distributable xx SE
Common Stock xx +SE
Note that the total effect on stockholders’ equity is zero. However, retained earnings decreases and common stock increases by the par value of the stock dividend.
Small stock dividends (< 25% of the outstanding common shares) are recorded at market value. Since small stock dividends are rare, we will not do journal entries here.

21. 6.Stock Splits
Stock splits are commonly declared by a company to reduce its market price per share. This makes the stock more accessible to small investors.
The process for stock splits is that the “old” stock certificates are turned in, and “new” stock certificates with a new description are issued to the same shareholders.
The total par value of the new shares is equal to the total par value of the old shares, but the number of shares (and par value per share changes.

22. 6.Example of Stock Split
IZM Company has 100,000 shares of $2 par value stock authorized, 10,000 shares issued and outstanding.
The SE section of the balance sheet shows:
Common stock $20,000
Retained earnings 80,000
The market price of the outstanding shares is $50 per share before the split is distributed.

23. 6.Example of Stock Split
If IZM declared a 2 for 1 stock split, the old shares would be turned in and new shares would be issued with the following description:
Common stock, $1 par value, 200,000 shares authorized, 20,000 shares issued and outstanding.
The total SE is still $100,000:
Common stock $20,000
Retained earnings 80,000
The market price per outstanding share would now be $25 per share.
Note: No journal entry is necessary.

24. 6. Stock Dividends vs Stock Splits
Now note the new description for the stock dividend:
Common stock, $2 par value, 100,000 shares authorized, 20,000 shares issued and outstanding
The total value in SE is still $100,000:
Common Stock $40,000
Retained Earnings 60,000
Note that the total market price per share would change to $25 per share.
Thus, a 2 for 1 stock split and a 100% stock dividend have the same effect on:
total stockholders’ equity and
market price per share

25. 6. Stock Dividends vs Stock Splits
However, a stock dividend requires a journal entry, which changes the components of SE (RE and CS).
A stock split changes the description of the shares, including the par value per share.
Most companies use a stock split to change the market price per share, but some companies use the large stock dividend to achieve the same result. This action is called a “stock split in the form of a dividend.”

26. 6. Stock Dividends vs Stock Splits
To summarize the effects on IZM Company:
100% Stock 2 for 1
After: Dividend Stock Split
Total sh. outstanding ,000 sh. 20,000 sh.
Par value per share $ $1
Market price per share $ $25
Total stockholders’ eq: $100,000 $100,000
General ledger results:
CS account $ 40,000 $ 20,000
RE account $ 60,000 $ 80,000
Reminder: CS was $20,000 and RE was $80,000 before the split or dividend. Since the stock dividend required journal entries, the amounts for CS and RE changed. Since the stock split does not require a journal entry, the amounts for CS and RE do not change.

27. 7. Statement of Stockholders’ Equity
In this chapter, we have discussed the Statement of Retained Earnings as the link between the balance sheet and the income statement.
However, earlier chapters introduced the Statement of Stockholders’ Equity, which has become the default statement for large companies in recent years.
The Statement of Stockholders’ Equity details the change in retained earnings, including all the changes discussed in this chapter, and it also shows the change during the year in all of the stockholders’ equity accounts.