Stockholders' Equity (ASC 505)

1. Contributed capital Capital stock Additional paid-in capital (APIC) (also called Capital in excess of par or Paid-in capital in excess of par) Treasury stock 2. Reinvested (or Retained) earnings 3. Other comprehensive income items (ASC 220) Unrealized gains and losses on investments (will discuss under investments) Unrealized gains and losses on cash flow hedges (will discuss under derivatives) Excess of additional pension liability over unrecognized prior service cost (will discuss under pensions) Unrealized foreign currency gains and losses (discussed in advanced accounting) Important Point - Accounting for stockholders' equity always follows the provisions of corporate law in the company's state of incorporation. These laws vary from state to state, and it is always good practice to consult with an attorney regarding specific questions in this area. I - Stock Issuance Question? At what value is newly issued stock recorded? Journal entry when stock is issued:

Costs incurred in issuing stock Simply treat as a reduction of the amounts recorded in Contributed Capital of APIC, if par value stock of common stock, if the stock is no-par stock Note: Companies used to have the option to treat these expenditures as an organization cost, and amortize them over a period not to exceed 40 years Stock issued on a subscription basis Subscriptions receivable Common (or preferred) stock subscribed APIC Question? What type of account is Subscriptions Receivable?
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XXX XXX XXX

When cash is received Cash Subscription receivable When the stock is completely paid Common stock subscribed Common stock II - Types of Stock Common Voting Classes Preemptive right Par No par Stated value Authorized Issued Outstanding Preferred Preference with respect to dividends and in liquidation in the case of bankruptcy Is generally nonvoting Generally no preemptive right Often convertible - the book value (of the preferred stock) method is used to record the conversion Preferred stock XXX APIC - Preferred stock XXX Common stock XXX APIC - Common stock XXX May be callable Dividends - generally stated as a percentage of par Very often the dividends are cumulative Much less frequently, they may be participating
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XXX XXX

XXX XXX

III - Dividends Dividends are proportionate (according to the class of stock) distributions to stockholder's of the following items. Except for stock dividends, the distribution results in a reduction of stockholders' equity. Dates Cash Declaration Property Script (IOU's) Record Liquidating Stock Payment Journal entry Dividends declared Dividends payable

XXX XXX

Dividends payable Cash

XXX XXX

Question? What is the effect of the dividend declaration on the Statement of Cash Flows? Date of payment? Preferred stock dividends Cumulative preferred stock - If preferred stock is not cumulative, any skipped dividends are lost. However, most preferred stock is cumulative. Dividends not paid become dividends in arrears, and dividends in arrears must be paid before any dividends can be distributed to common stockholders. Participating preferred stock (This is much less common) - May be one of two varieties: Fully participating - Preferred stockholder's share proportionately (with the common stockholders) in any distributions beyond the stated preferred dividend rate if the total dividend package is large enough so that common stockholders also receive the preference rate. Partially participating - Similar to fully participating, but the participation is limited by a ceiling (a percentage cap on the participation). Example 1 Windal Corporation indicated that the following dollar amounts would be available for dividends during four successive years: $1,000, $2,000, $1,000, and $23,000. The capital stock outstanding consisted of $70,000 of common stock (par value: $20 per share) and $30,000 of 5%, $10 par value preferred stock. Case I - Preferred is noncumulative and nonparticipating Preferred Stock Year 1 Year 2 Year 3 Year 4 Common Stock

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Dividends: Year 1 - $1,000; Year 2 - $2,000; Year 3 - $1,000; Year 4 - $23,000 Case II - Preferred is cumulative and nonparticipating Preferred Stock Year 1 Year 2 Year 3 Year 4 Common Stock

Case III - Preferred is noncumulative and fully participating Preferred Stock Common Stock Year 1 Year 2 Year 3 Year 4

Case IV - Preferred is cumulative and fully participating Preferred Stock Common Stock Year 1 1,000 Year 2 500 + 1,500 = 2,000 Year 3 1,000 Year 4 500 + 1,500 + 5,250 = 3,500 + 12,250 = 15,750 7,250

Case V - Preferred is noncumulative and partially participating (up to an additional 2%) Preferred Stock Common Stock Year 1 1,000 Year 2 1,500 500 Year 3 1,000 Year 4 1,500 + 600 = 2,100 3,500 + 1,400 + 16,000 = 20,900

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Stock dividends (a capitalization of reinvested earnings) - Stock dividends come in two varieties: Small stock dividends (< 20 - 25%. SEC uses 25%). The par value remains the same but the number of shares outstanding increases. Capitalize retained earnings and do at market value Retained earnings (stock dividends declared) Common stock APIC XXX XXX XXX

Large stock dividends (> 20 - 25%) The par value remains the same but the number of shares outstanding increases. The accounting treatment also depends on state law. Capitalize retained earnings, but do it at par value Retained earnings (stock dividends declared) Common stock XXX XXX

ASC 505-20-30-6 states that retained earnings need to be capitalized only "to the extent occasioned by legal requirements." Consequently, if the applicable state laws do not require the capitalization of retained earnings, then GAAP does not either. Stock splits - General rule (textbook treatment) is that no journal entry is required, but the accounting treatment also depends on state law. Adjust the par value downward or upward depending on the direction of the split The number of shares outstanding also increases or decreases depending on the direction of the split. Note: For large stock dividends and stock splits, you frequently observe the following entry in practice (allowed in about 2/3 of the states): APIC (at par value) Common stock Question: What does a stock split signal to the market place? Question: What does a stock dividend signal to the market place? Question: What is the effect of either of these transactions on the SCF? XXX XXX

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Example 2 - Small stock dividend Outdoor Equipment Suppliers, Inc. 2010 Financial Statements Dividends: On October 22, 2010, the Company declared a 10 percent stock dividend to shareholders of record on November 1, 2010. Accordingly, the fair market value of the stock dividend determined as of the declaration date was transferred from retained earnings to common stock and additional paid-in capital. Example 3 - Large stock dividend William Horton Corporation 2010 Financial Statements Note L: Stockholders' Equity The company effected a two-for-one stock split in the form of a 100% stock dividend on May 29, 2010, which served to capitalize approximately $5,523,000 of retained earnings. All net income per common share and dividends per share have been adjusted, as applicable, to give retroactive effect to this split. Example 4 - Stock split Western Furniture, Inc. 2010 Financial Statements Note 16: On March 2, 2010, the Board of Directors authorized, subject to shareholder approval, a one-for-three reverse split of the Company's common stock. If this proposed split is approved by the shareholders on May 12, 2010, the par value of the common stock will increase to $0.30 per share. Additionally, the number of common shares outstanding will decrease by two-thirds and per share data for all periods presented will increase accordingly. Example 5 - Stock split Post Oak Company 2010 Financial Statement
Note 7 (in Part): Common stock and other capital. On December 3, 2010, shareholders approved an increase in the authorized shares of common stock from 165 million to 330 million and approved a two-for-one stock split to shareholders of record on December 4, 2010. The stated par value per share of common stock was not changed from $.25. All share and per share amounts have been restated to retroactively reflect the stock split. (in millions) Balance, January 1, 2008 Stock options exercised Treasury stock purchases Balance, December 31, 2008 Stock options exercised Treasury stock purchased Balance, December 31, 2009 Stock options exercised Two-for-one stock split Treasury stock purchased Balance, December 31, 2010 Common stock $38.5 .1 38.6 38.6 .1 38.7 $77.4 Capital in excess of par value $63.3 9.5 72.8 8.4 81.2 17.1 (38.7) $60.2 Treasury stock $631.8 78.6 710.4 86.9 797.3 83.6 $880.9

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IV - Treasury Stock Journal entry Treasury stock Cash Question? What type of account is treasury stock? Question? Where do you find treasury stock disclosed on the financial statements? Question? Why do companies buy back their own stock? XXX XXX

Question? Is a company legally obligated to buy back its shares after it announces its intentions to do so? Example 6 In June of 2008, Eastern Digital Corp. said publicly that it would repurchase as much as 10% of its common stock on the open market in the next year. The maker of computer disk drives said it would use the repurchased shares for its employee-benefit plans. Eastern Digital Corporation 2010 Consolidated Balance Sheet (in part) (in thousands, except per share amounts)
June 29 2010 Shareholders' equity (Notes 3 and 6): Preferred stock, $.10 par value; Authorized -- 5,000 shares; Outstanding -- None Common stock, $.10 par value; Authorized -- 95,000 shares; Issued -- 50,666 shares in 2010 and 50,482 shares in 2009 Additional paid-in capital Retained earnings Treasury stock-common shares at cost; 7,095 shares in 2010 and 805 shares in 2009 Total shareholders' equity July 1 2009

5,066 349,773 220,470 (121,417) 453,892

5,048 355,624 123,576 (10,822) 473,426

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Eastern Digital Corporation 2010 Statement of Shareholders' Equity (in part) (in thousands)
Common Stock Shares Balance at June 30, 2008 ...................... Purchase of treasury stock Balance at July 1, 2009 Purchase of treasury stock Exercise of stock options ESPP shares issued Balance at June 29, 2010 Treasury Stock Shares -0(805) (805) (7,720) 784 646 (7,095)

Amount

Amount -0(10,822) (10,822) (132,114) 12,833 8,686 (121,417)

APIC

50,482 184 50,666 18

(309)

Treasury stock accounting - Gains or losses are never recognized as a result of treasury stock transactions. Two methods Cost method - This is the most frequently used method. The treasury stock account is debited for the cost of the shares acquired and is credited upon reissuance for the same cost. Note that the price originally received upon issuance of the stock does not affect these entries. Differences between reacquisition price and any subsequent sale price affect APIC (and possibly retained earnings). Journal entry for the purchase of treasury stock Treasury stock Cash Journal entry for the resale of treasury stock (and the selling price > cost) XXX XXX

Journal entry for the resale of treasury stock (and the selling price < cost)

Par (or stated) value method - This method views the process as a two-step transaction and focuses on the stock's par value. First, the purchase of the shares is viewed as constructive retirement of those shares. If the shares are then resold, this transaction is treated like the sale of a new security. Note: Most states view the cost of treasury shares as a restriction on retained earnings.
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