1. 1 Chapter 12: Stockholders’ Equity Fundamentals of Intermediate Accounting Weygandt, Kieso and Warfield Prepared by Bonnie Harrison, College of Southern Maryland, LaPlata, Maryland

2. 2 Chapter 12 Stockholders’ Equity After studying this chapter, you should be able to: Discuss the characteristics of the corporate form of organization. Explain the key components of stockholders’ equity. Explain the accounting procedures for issuing shares of stock. Explain the accounting for treasury stock. Explain the accounting for and reporting of preferred stock. 1 2 3 4 5

3. 3 Chapter 12 Stockholders’ Equity After studying this chapter, you should be able to: Describe the policies used in distributing dividends. Identify the various forms of dividend distributions. Explain the accounting for small and large stock dividends, and for stock splits. Indicate how stockholders’ equity is presented and analyzed. 6 7 8 9

4. 4 Corporate Form: Characteristics Accounting for the corporate form is affected by:  the influence of state corporate law  the use of capital stock  the variety of ownership interests  the limited liability of the stockholders  the formality of the profit distribution

5. 5 The Rights of Stockholders tThe stockholders have the right to: 1) share proportionately in profits and losses 2) share proportionately in management 3) share proportionately in corporate assets upon liquidation 4) share proportionately in any new issues of stock of the same class (preemptive right)

6. 6 Components of Stockholders’ Equity n Stockholders’ equity is classified into: è contributed capital, and earned capital n Contributed capital (paid-in capital) : 1. is the amount advanced by stockholders for use in the business, and 2. includes the par value of stock and any premium or discount on issuance of stock n Earned capital consists of undistributed profits

7. 7 Components of Equity EQUITY Earned capital (Ret. Earn). CONTRIBUTED CAPITAL Less:T.Stock at COST Less: T.stock at PAR RestrictUNrest Paid-in capital Additional Paid-in commonpreferred common preferred

8. 8 Stockholders’ Liability n It is the stockholders’ liability that is limited - NOT the company’s ! n If PAR issue, liability is limited to amount invested by stockholder. n If PREMIUM issue, liability is limited to total investment by stockholder. n If DISCOUNT issue, liability equals amount invested plus discount at issue.

9. 9 Accounting for Share Issues t Accounts must be maintained for:  par value stock ò preferred stock or common stock ò paid-in capital in excess of par ò discount on stock  No par stock ò preferred stock or common stock ò paid-in capital in excess of par  Stock sold on a subscription basis

10. 10 n Par Value stock: – Record Common stock at PAR n No-Par Stock: – Entire sale proceeds go to Stock account. – Avoids stockholders’ contingent liability in discount stock issues – Avoids confusion between par and market values Equity - Stock Issues

11. 11 Stock Issued in Lump-sum Sales u Both COMMON and PREFERRED stocks are issued for cash in a single transaction u The two methods of allocation available are: 1) Proportional Method [relative fair market values] 2) Incremental Method

12. 12 Sale of Stock for Lump-sum: Example o Corporation issues common and preferred stock for lump-sum cash: è common stock: 1,000 shares; par, $10; fair market value, $20: è preferred stock: 1,000 shares ; par, $10; fair market value, $12; è cash received for issue: $30,000: o Show the allocation of cash under the Proportional method

13. 13 Sale of Stock for Lump-sum: Example Proportional Allocate cash received based on fair values of common and preferred stock: Allocate to common stock: ( 20000 / 32000) * 30,000 = $18,750 Common Allocate to preferred stock: (12000 / 32000) * 30,000 = $11,250 Preferred

14. 14 Sale of Stock for Lump-sum t Corporation issues common and preferred stock for lump-sum cash: t Common stock: 1,000 shares; par, $10; fmv, $20; t Preferred stock: 1,000 shares ; par, $10; è (fair market value of preferred stock, NOT clear.) t Cash received for issue: $30,000. è Show the allocation of cash under the Incremental method

15. 15 Sale of Stock for Lump-sum Incremental Cash Received: $30,000 Fair market value(c/st): (20,000) ====== Amount allocated to preferred stock $10,000 ======

16. 16 Stock Issuance for Other Than Cash When stock is issued for services or property other than cash, the property or services are recorded at 1)either the fair value of the stock issued OR 2)the fair value of non-cash consideration received, whichever is more clearly determinable

17. 17 Treasury Stock t Outstanding stock, purchased by the corporation, is known as treasury stock. t The reasons as to why corporations buy back their outstanding stock include: 1) to increase earnings per share and return on equity 2) to provide tax efficient distributions of excess cash to shareholders 3) to provide stock for employee stock compensation contracts 4) to thwart takeover attempts 5) to create or improve the market for the stock

18. 18 Treasury Stock: Concepts wTreasury stock represents reacquired (outstanding) common stock wTreasury stock IS NOT an asset w Steps in treasury stock transactions: 1) Initially, corporations issue stock from authorized stock 2) From issued (and outstanding) stock, corporations may reacquire the stock [=T/Stock] 3) Treasury stock may be resold: when resold, it becomes issued stock. 4) T/Stock may be retired or removed from the books.

19. 19 Recording Treasury Stock: Methods n COST METHOD: – Treasury stock is recorded at purchase COST – It is a CONTRA-EQUITY account (shown as a reduction of equity in the Stockholders’ Equity section) n PAR VALUE METHOD: – Treasury stock is recorded at PAR value – It is a contra account to the common stock account

20. 20 Treasury Stock: Cost Method uThe cost method is generally used to account for treasury stock uUnder the cost method: 1)debit treasury stock for purchase cost, and 2)credit treasury stock for this same cost upon reissue èThe initial issue price of stock does not affect subsequent treasury stock transactions

21. 21 Treasury Stock: Cost Method uGiven: 1) Issued: 1,000 common shares; Par, $100; issued at $110. 2) Reacquired: 100 shares at $112 each. 3) 10 shares were reissued at $112 (at cost) 4) 10 shares were reissued at $130 (above cost) 5) 10 shares were reissued at $98 (below cost) 6) 10 shares reissued at $105 (below cost) è Show journal entries for the stock transactions

22. 22 Treasury Stock: Cost Method Debit Credit Issued: (par, $100); 1,000 sh. at $110. Cash 110,000 Common stock 100,000 Additional PIC: common stock 10,000 1 10 shares reissued @ 112 Cash 1,120 Treasury stock 1,120 3 Reacquired: 100 at $112. Treasury stock 11,200 Cash 11,200 2

23. 23 Treasury Stock: Cost Method Debit Credit 10 shares reissued at 130 Cash 1,300 Treasury stock 1,120 Additional PIC: Treasury stock 180 4 10 shares reissued at $98 Cash 980 Additional PIC: (T/stock) 140 Treasury stock 1,120 5

24. 24 Treasury stock: cost method- contd. Cash 1,050 Addl PIC (t/stock) 40 Retained Earnings 30 Treasury stock 1120 Reissued 10 treasury shares at $105 6 Use Additional PIC (treasury stock) first to absorb any shortfall. Then, use retained earnings

25. 25 RETIREMENT OF TREASURY STOCK l Repurchase of stock does NOT mean retirement l Retired stock must be cancelled. l Retired stock becomes authorized and unissued stock l Similar to sale of treasury stock, except debits are made to Paid in Capital accounts (instead of cash)

26. 26 Treasury stock: Retirement (cost method) l Given: 10 treasury shares are retired. l Common shares (par, $100) had originally been issued at $110. l Provide the journal entries under the following assumptions: 1) The 10 shares of treasury stock were acquired at $112. 2) The 10 shares of treasury stock were acquired at $98.

27. 27 Treasury stock: Retirement (cost method) Treasury stock, acquired at $112: C/stock 1,000 PIC:c/st 100 Ret.Earn. 20 T/Stock 1,120 1 Treasury stock, acquired at $98. C/stock 1,000 PIC: c/st 100 T/stock 980 PIC: from retired common st 120 2

28. 28 Preferred Stock tPreferred stock has certain preferences or features not possessed by common stock tThese features include: 1) preference as to dividends 2) preference as to assets in the event of liquidation 3) convertibility into common stock at the option of the stockholders 4) callability at the option of the corporation 5) absence of voting rights

29. 29 Preferred Stock: Features n Cumulative preferred stock n Participating preferred stock: – Fully Participating – Partially Participating n Convertible preferred stock n Callable preferred stock n Redeemable preferred stock, not equity

30. 30 Restricted Payment of Dividends  Dividend payments may be subject to covenant restrictions  No dividends are payable on treasury stock  Earnings may be reinvested  Corporation may smooth out dividends paid over the years (to avoid fluctuations)  Corporations may build up a cushion of profits

31. 31 Types Of Dividends 1) Cash dividends 2) Property dividends 3) Stock dividends 4) Liquidating dividends [return of capital]

32. 32 Cash Dividends: Important Dates t There are three important dates : 1. the declaration date ( dividends are declared and accrued) 2. the record date ( list of stockholders to whom dividends are to be paid is finalized) 3. the payment date ( dividends are paid to stockholders of record )

33. 33 Cash Dividends: Journal Entries 1) DATE DECLARED 2) DATE OF RECORD 3) DATE of PAYMENT 1) Retained Earn Dividends Payable 2) No Entry 3) Dividends Payable Cash

34. 34 PROPERTY DIVIDENDS w are payable in assets of company w are non-reciprocal transfers between corporation and shareholders w are equal to the fair market value of assets distributed at time of declaration [except in spin-offs and reorganizations] w Corporation recognizes gain / loss on the distribution.

35. 35 Property Dividend:Entries ç Given: Company distributes certain marketable securities to stockholders. ç Dividend is declared on Dec 21, 2002 and is payable on Jan 21, 2003 to stockholders of record on Jan 14, 2003. ç Fair value of securities is $134,000 on Dec 21, 2002 and $ 135,900 on Jan 21, 2003. ç COST of securities is $ 110,000. èProvide the journal entries on the dates of declaration, record, and payment.

36. 36 Property Dividend:Entries 1 Declaration Date Investments 24,000 Gain on Apprec. 24,000 2 Declaration Date Retain. Earn 134,000 Prop. Div.Pay. 134,000 3 Payment Date Prop. Div. Pay 134,000 Investments 134,000

37. 37 LIQUIDATING DIVIDENDS w are a return of corporate paid-in capital w might be distributed, when corporation is winding up operations w are specified as to income and capital portions w reduce paid-in capital.

38. 38 Stock Dividends: Concept w Stock dividends result in more shares being issued as dividend (no assets are involved) w Small stock dividends involve issues of less than 20% - 25% of stock. w The accounting for small stock dividends is based on the fair market value of stock issued. w The accounting for large stock dividends (more than 20%-25%) is based on the par value of stock issued.

39. 39 Stock Dividends Types of Dividends Less than 20 - 25% shares More than 20 - 25% shares Use FMV at declaration Use FMV at declaration Use par value Use par value Small Dividend Large dividend

40. 40 Stock Dividends: Journal Entries n Given: n Outstanding stock: 1,000 shares; $10 par n Stock dividend: 10% n FMV on date of declaration: $12 n Provide the journal entries on the declaration date and the distribution date

41. 41 Stock Dividends: Small Issue Declaration Ret. Earnings $1,200 C/stock Distributable$1,000 Paid-in Capital (excess) 200 Distribution C/ stock distributable $1,000 Common stock$1,000 Stock dividend = 10% of 1,000 shares = 100 shares

42. 42 Stock Dividends: Large Issue n Given: n Outstanding stock: 3,000 shares; $10 par n Stock dividend: 30% n FMV on date of declaration: $12 n Provide the journal entries on the declaration date and the distribution date

43. 43 Stock Dividends: Large Issue Declaration Ret. Earnings $9,000 C/stock Distributable$9,000 Distribution C/ stock distributable $9,000 Common stock$9,000 Stock dividend = 30% of 3,000 shares = 900 shares

44. 44 STOCK SPLITS r Each share is made smaller r Par value of each share decreases; number of shares increases r Total par value is unchanged r Stock splits do not change total equity r No formal journal entry is made to record stock splits [only a memo entry is made] r Splits make shares more accessible to the public

45. 45 Stock Dividends and Stock Splits 1) Par value of a share does not change 2) Total number of shares increases 3) Total stockholders’ equity does not change 4) The composition of equity changes (less of retained earnings; more of stock) 5) Stock dividends require journal entries 1) Par value of a share does not change 2) Total number of shares increases 3) Total stockholders’ equity does not change 4) The composition of equity changes (less of retained earnings; more of stock) 5) Stock dividends require journal entries 1) Par value of a share decreases 2) Total number of shares increases 3) Total stockholders’ equity does not change 4) The composition of equity does not change (same amounts of stock and RE) 5) Stock splits do not require journal entries 1) Par value of a share decreases 2) Total number of shares increases 3) Total stockholders’ equity does not change 4) The composition of equity does not change (same amounts of stock and RE) 5) Stock splits do not require journal entries Stock DividendsStock Splits

46. 46 Presentation of Stockholders’ Equity Frequently presented in the following basic format:  Balance at the beginning of the period  Additions  Deductions  Balance at the end of the period

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