Financial Accounting:

Tools for Business Decision Making, 4th Ed.

Kimmel, Weygandt, Kieso

CHAPTER 11
Prepared by
Ellen L. Sweatt
Georgia Perimeter College
and

Barbara Muller
Arizona State University West

Chapter 11
REPORTING AND
ANALYZING
STOCKHOLDERS
EQUITY

Reporting and Analyzing

Stockholders Equity

After studying Chapter 11, you

should be able to:
Identify and discuss the major
characteristics of a corporation.
Record the issuance of common
stock.
Explain the accounting for the
purchase of treasury stock.
Differentiate preferred stock from
common stock.

Reporting and Analyzing

Stockholders Equity

Prepare the entries for cash

dividends and understand the effect
of stock dividends and stock splits.
Identify the items that affect
retained earnings.
Prepare a comprehensive
stockholders' equity section.
Evaluate a corporation's dividend
and earnings performance from a
stockholder's perspective.
4

Corporation

Created by law
Legal entity
Has most of the rights and
privileges of a person
Classified by purpose and
ownership
Purpose - profit or nonprofit
Ownership - publicly or privately
held
5

Publicly Held Corporation...

May have thousands of stockholders.
Its stock is regularly traded on national
securities markets.

Privately Held
Corporation...
Usually has only a few stockholders and
does not offer its stock for sale to general
public.

11

Characteristics of a
Corporation
Separate legal existence
Limited liability of stockholders
Transferable ownership rights
Ability to acquire capital
Continuous life
Corporation management
Government regulations
Additional taxes
7

Separate Legal Existence

Separate and distinct from

its owners.
Acts under its own name.
May buy, own, sell
property; borrow money;
enter into legally binding
contracts; may sue or be
sued; pays its own taxes.
Owners (stockholders)
cannot bind corporation
unless owners are agents
of the corporation.

Limited Liability of Stockholders

Creditors have recourse only

to corporate assets to satisfy
their claims.
Liability of stockholders
limited to their investment in
their corporation.
Creditors have no legal claim
on personal assets
of stockholders unless fraud
has occurred.
Stockholders losses limited to
amount of capital invested.
9

Transferable Ownership Rights

Ownership evidenced by shares of stock

Transfer of ownership among stockholder
has no effect on corporations operating
activities or assets,
liabilities and total
stockholders' equity.
Corporation does not
participate in transfer of
ownership rights
after original sale.
10

Ability to Acquire Capital

Limited liability of stockholders
coupled with transferable
ownership rights make it easy to
raise capital.

11

Continuous Life

Life of corporation is stated in its

charter - may be perpetual or limited to
specific number of years (can be
extended).
Corporation is separate
legal entity, thus life
not affected by
withdrawal, death,
or incapacity of a stockholder.

12

Corporation Management

The corporation establishes by-laws

upon receipt of its charter from the
state of incorporation.
Stockholders manage corporation
indirectly through board of
directors.
Board of directors
formulates operating policies
selects officers to execute policy and to
perform daily management functions.
13

Corporate Organization
Chart

15

Additional Taxes

16

Forming a Corporation

A corporation can operate in

various states (must have a
license from each state in
which it does business) but can
be incorporated in only one
state.

17

Stockholder Rights

Once chartered, the corporation

sells stock .
If only one class of stock - called
common stock.
Ownership rights specified in the
articles of incorporation or bylaws.
Proof of stock ownership is a
printed or engraved form known
as a stock certificate.
18

19

Stock Certificate Shows...

Name of the corporation
Stockholder's name
Class and special features of the
stock
The number of shares owned
The signatures of
duly authorized
corporate officials.

20

Questions in Issuing Stock...

How many shares should be

authorized for sale?

How should the stock be issued?

At what price should the shares

be issued?

22

Authorized
Maximum
amountStock...
of stock a
corporation is allowed to sell as
authorized by corporate charter.
Issued Stock...

Number of shares of issued stock

have been sold and been paid for.

Outstanding Stock...

Number of shares of issued stock

that are being held by stockholders.
23

Corporations Can Issue Stock

Directly to investors (typical in

privately held corporations).
Indirectly through an
investment banking firm
(customary with publicly held
corporations).

24

Par Value Stock...

Is capital stock that has been

assigned a value per share in the
corporate charter.

Legal capital per share must be

retained in the business for the
protection of corporate creditors.

25

No-Par Value Stock...

Capital stock that has not been

assigned a value per share in the
corporate charter.

Stated Value of No-Par

Stock

Amount per share assigned by the

board of directors to no-par stock.
Par Value and Stated Value have NO
relationship to market value.
26

Stockholders Equity Section of a

Corporations Balance Sheet
Two Parts:
Paid-in (contributed) capital - Amount paid to
corporation by stockholders in exchange for
shares of ownership.

Retained earnings (earned capital) Earned capital held for future use in the business.

27


Review
Whichofthefollowingrepresentsthe
maximumnumberofsharesacorporationcan
issue?
a. Outstandingshares
b. Issuedshares
c. AuthorizedShares
d. TreasuryShares
28


Review
Whichofthefollowingrepresentsthe
maximumnumberofsharesacorporationcan
issue?
a. Outstandingshares
b. Issuedshares
c. AuthorizedShares
d. TreasuryShares
29

Accounting for
Common Stock Issues

11

The issue of common stock affects

only paid-in capital accounts.
When the issuance of common
stock for cash is recorded, the par
value of the shares is credited to
common stock.
The portion of the proceeds above
or below par value is recorded in a
separate paid-in capital account.
30

Issuing Stock at Par

Hydro-Slide, Inc., issues 1,000 shares
of $1 par value of common stock at
par for cash.
Cash
Common Stock

1,000
1,000

31

Issuing Stock Above Par

If Hydro-Slide, Inc., issues an additional
1,000 shares of the $1 par value
common stock for cash at $5 per share,
the entry is:
Cash
5,000
Common Stock
1,000
Paid-in Capital in
Excess of Par Value

4,000

32

Hydro-Slide, Inc.
Balance Sheet (partial)
Stockholders' equity
Paid-in capital
Common stock
Paid-in capital in excess of par
Total paid-in capital
Retained earnings
Total stockholders' equity

$ 2,000
4,000
$ 6,000
27,000
$33,000

Mead, Inc.
Balance Sheet (partial)
Stockholders' equity
Paid-in capital
Common stock,$5par value,
100,000 shares issued and
outstanding
Retained Earnings
Total stockholders equity
700,000

$ 500,000
200,000
$

BEFORE TREASURY STOCK TRANSACTION

11

Treasury Stock...

Is a corporation's own stock

that has been issued
fully paid for
reacquired by the corporation
held in its treasury for future use .

35

Corporations Acquire Treasury

Stock to...

Reissue shares to officers and employees

under bonus and stock compensation
plans.
Increase trading of company's stock in
securities market in hopes of enhancing
market value.
Have additional shares available for use
in acquisition of other companies.
Reduce number of shares outstanding
thereby increasing earnings per share.
36
Prevent a hostile takeover.

Purchase of Treasury Stock

On February 1, 2007, Mead
acquires
4,000 shares of its
stock at $8 per share.

Treasury Stock
Cash

32,000
32,000

37

Treasury Stock

The Treasury Stock account would increase

by the cost of the shares purchased $32,000.
The original paid-in capital account,
Common Stock, would not be affected
because the number of issued shares does
not change.
Treasury stock is deducted from total paidin capital and retained earnings in the
stockholders' equity section of the balance
sheet.
38

Mead, Inc.
Balance Sheet (partial)
Stockholders' equity
Paid-in capital
Common stock,$5par value,
100,000 shares issued and
96,000 outstanding
Retained Earnings
Total stockholders equity
700,000
Less: Treasury Stock
32,000
Total stockholders equity

$ 500,000
200,000

$ 668,000

AFTER TREASURY STOCK TRANSACTION

Review
Inthestockholdersequitysection,thecost
oftreasurystockisdeductedfrom:
a. totalpaid-incapitalandretainedearnings
b. retainedearnings
c. totalstockholdersequity
d. commonstockinpaid-in-capital
40

Review
Inthestockholdersequitysection,thecost
oftreasurystockisdeductedfrom:
a. totalpaid-incapitalandretainedearnings
b. retainedearnings
c. totalstockholdersequity
d. commonstockinpaid-in-capital
41

Preferred Stock...

11

Capital stock that has

contractual preferences over
common stock in certain areas.

Dividends
Assets in the event of liquidation

Preferred stockholders do not have

voting rights.
42

Preferred Stock

Assume Corporation issues 10,000 shares of

$10 par value preferred stock for $12 cash
per share.
Cash
120,000
Preferred Stock
100,000
Paid-in Capital in Excess
20,000
of Par Value--Preferred Stock
(Preferred stock may have either a par value or
no-par value.)

43

Dividend Preferences

Preferred stockholders have the right

to share in the distribution of
corporate income before common
stockholders.
The first claim to dividends does not
guarantee dividends.

44

Cumulative Dividend...
Is a feature of preferred stock
entitling the stockholder to receive
current and unpaid prior-year
dividends before common
stockholders receive any dividends.

45

Dividends in Arrears...

Are preferred dividends that

were scheduled to be declared
but were not declared during a
given period.
Are not a liability. No
obligation exists until a
dividend is declared by the
board of directors.
Must be disclosed in the notes
to the financial statements.

46

Dividends in Arrears
Scientific-Leasing has 5,000 shares of 7%, $100
par value cumulative preferred stock
outstanding.
The annual dividend is $35,000 (5,000 x $7 per
share).
Dividends are 2 years in arrears
Dividends in arrears ($35,000 x 2 years)
Current-year dividends
Total preferred dividends
$105,000

$ 70,000
35,000

47

Liquidation Preference
Is a feature that gives
preferred stockholders
preference to corporate assets
in the event of liquidation.

48

11

Dividend...

Is a distribution by a corporation to
its stockholders on a pro rata basis.
Pro rata means that if you own 10%
of the common shares, you will
receive 10% of the dividend.
Dividend forms:
cash
property
script (promissory note to pay cash)
stock
49

Cash Dividend

Is a pro rata distribution of cash

to stockholders.
A corporation must have 3
things to pay cash dividends:
Retained earnings
Adequate cash
Declared dividends
50

Cash Dividend

In many states, payment of dividends

from legal capital is prohibited.
Payment of dividends from paid-in
capital in excess of par is legal in
some states.
Payment of dividends from retained
earnings is legal in all states.
Companies are frequently
constrained by agreements with
lenders to pay dividends only from
retained earnings.

51

Entries for Cash Dividends

Three dates are important

in connection with
dividends:
the declaration date
the record date
the payment date Montha ndye a r
Monday

Tue sday

Wedne sday

Thursday

Friday

Saturday

Sunday

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

52

The Declaration Date...

Is the date the board of directors

declares the cash dividend.
Commits the corporation to a binding
legal obligation that cannot be

On December
1, 2007, the directors of Media
rescinded.
General declare a $.50 per share cash dividend
on 100,000 shares of $10 par value common
stock.
The dividend is $50,000 (100,000 x $.50).
12/1

Retained Earnings
Dividends Payable

50,000

50,000
53

The Record Date...

The date ownership of the outstanding shares is
determined for dividend purposes.
Dec 20
No Entry Necessary.

The Payment Date...

The date dividend checks are mailed.
January 20 is the payment date for Media
General.
Jan 20 Dividends Payable
Cash

50,000
50,000

54

A Stock Dividend...

Is a pro rata distribution of the

corporation's own stock to stockholders.
Is paid in stock.
Results in a decrease in retained
earnings and an increase in paid-in
capital.
Does not decrease total stockholders'
equity or total assets.
Is often issued by companies that do not
have adequate cash to issue a cash
dividend.
55

Stock Dividends

You have a 2% ownership interest in

Cetus Inc., owning 20 of its 1,000
shares of common stock.
In a 10% stock dividend, 100 shares
(1,000 x 10%) of stock would be
issued. You would receive two shares
(2% x 100), but your ownership
interest would remain at 2% (22 /
1,100).
You now own more shares of stock, but
your ownership interest has not
changed.
56

Reasons for Stock

Dividends

To satisfy stockholders' dividend

expectations without spending cash.
To increase marketability of its stock
by increasing number of shares
outstanding and decreasing market
price per share.
To emphasize that a portion of
stockholders' equity has been
permanently reinvested in business
and is unavailable for cash dividends.
57

Stock Dividends

A small stock dividend (less than

20%-25% of the corporation's
issued stock) is recorded at the
fair market value per share.
A large stock dividend (greater
than 20%-25% of the corporation's
issued stock) is recorded at par or
stated value per share.
58

Stock Split
Because a stock split does not
affect the balances in
stockholders' equity accounts, it
is not necessary to journalize a
stock split.

59

Stock Split...

Is the issuance of additional shares of

stock to stockholders accompanied by:
A reduction in the par or stated value.
An increase in number of shares.
A stock split does not have any effect
on total paid-in capital, retained
earnings, and total stockholders' equity.

60

Review

Vista,Inc.had300,000sharesofcommonstockoutstanding
whena30%stockdividendwasdeclaredandissued.Howmany
shareswereoutstandingafterthestockdividend?
a. 390,000
b. 330,000
c. 300,000
d. 309,000

61

Review

Vista,Inc.had300,000sharesofcommonstockoutstanding
whena30%stockdividendwasdeclaredandissued.Howmany
shareswereoutstandingafterthestockdividend?
a. 390,000
b. 330,000
c. 300,000
d. 309,000

62

11

Retained
Earnings...
Is net income that is retained in
the business.
The balance in retained earnings
is part of the stockholders' claim
on the total assets of the
corporation.
Retained earnings does not
represent a claim on any specific
asset.
63

Deficit
Is a debit balance in retained
earnings and is reported as a
deduction in the stockholders'
equity section of the balance
sheet.

64

Retained Earnings
Restrictions...
Are legal, contractual or
voluntary circumstances that
make a portion of retained
earnings currently unavailable
for dividends.

65

Stockholders Equity with

Deficit

66

11

The Payout Ratio =

CASH DIVIDENDS DECLARED ON COMMON STOCK

NET INCOME

measures the percentage of earnin

distributed in the form of cash dividend
to common stockholders.

69

Return on Common
Stockholders Equity Ratio =
NET INCOME - PREFERRED STOCK DIVIDENDS
AVERAGE COMMON STOCKHOLDERS EQUITY

...measures the profitability from

the stockholders point of view.

70

Advantages of Bond Financing

Over Common Stock

Relationship of Par and No-Par

Value to Legal Capital
Stock
Par value

Legal Capital Per

Share
Par value

No-par value with Stated value

stated value
No-par value
Entire proceeds
without stated
value

72

Stock Dividends

Medland Corporation has $300,000 in

retained earnings and declares a 10%
stock dividend on its 50,000 shares of
$10 par value common stock.
The current fair market value of the
stock is $15 per share.

Retained Earnings
75,000
Common Stock Dividends
50,000
Distributable
Paid-in Capital in Excess
25,000
73
of Par Value

Review

Rogerisnearingretirementandwouldliketoinvestinastock
thatwillprovideagoodsteadyincomesupply.Rogershould
chooseastockwitha:
a)highcurrentratio.
b)highdividendpayout.
c)highearningspershare.
d)highpriceearningsratio.

74

Review

Rogerisnearingretirementandwouldliketoinvestinastock
thatwillprovideagoodsteadyincomesupply.Rogershould
chooseastockwitha:
a)highcurrentratio.
b)highdividendpayout.
c)highearningspershare.
d)highpriceearningsratio.

75

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