Financial Accounting - Chapter 11

Chapter 11
Stockholders Equity
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Learning Objectives
LO1 Understand the concept of stockholders equity and identify
the components of the Stockholders Equity category.
LO2 Show that you understand the characteristics of common
and preferred stock and the differences between the
classes of stock.
LO3 Determine the financial statement impact when stock is
issued for cash or for other consideration.
LO4 Describe the financial statement impact of stock treated as
treasury stock.
LO5 Compute the amount of cash dividends when a firm has
issued both preferred and common stock.
Learning Objectives (continued)
LO6 Show that you understand the difference between cash and
stock dividends and the effect of stock dividends.
LO7 Determine the difference between stock dividends and
stock splits.
LO8 Show that you understand the statement of stockholders
equity and comprehensive income.
LO9 Understand how investors use ratios to evaluate
stockholders equity.
LO10 Explain the effects that transactions involving stockholders
equity have on the statement of cash flows.
Learning Objectives (continued)
LO11 Describe the important differences between the sole
proprietorship and partnership forms of organization
versus the corporate form (Appendix).
Module 1 Stockholders Equity,
Issuance of Stock, and Treasury
Stock
There are various components presented in the
Stockholders Equity section of the balance
sheet
There are different types of stock that
companies can issue and there are advantages
of each class of stock
Treasury stock is important
2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 1
Stockholders Equity
Owners of a corporation and have a residual
interest in assets after liabilities are satisfied
2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 1: LO 1
Exhibit 11-1Advantages and
Disadvantages of Stock versus Debt
Financing
Stockholders Equity on the Balance
Sheet
The basic accounting equation:
Assets = Liabilities + Stockholders Equity
Two major components or subcategories:

Contributed Capital
Retained Earnings
Total Stockholders Equity = Contributed Capital + Retained Earnings
Components of the Stockholders
Equity Section of the Balance Sheet
Number of Shares
Par Value
Additional Paid-In Capital
Retained Earnings
Exhibit 11-2Retained Earnings
Connects the Income Statement
and the Balance Sheet
Contributed Capital
Common stock
Carries voting rights
The common stockholders elect the corporations
officers
Establish its bylaws and governing rules
Preferred stock
Flexibleand tailored to a companys needs
Preference in dividends
Number of Shares
Authorized shares: the maximum number of
shares a corporation may issue as indicated in
the corporate charter
Issued shares: the number of shares sold or
distributed to stockholders
Outstanding shares: the number of shares
issued less the number of shares held as
treasury stock
Par Value
An arbitrary amount that represents the legal
capital of the firm
Stated on the face of the stock certificate
Also called stated value
Amount presented in the stock account
Additional Paid-In Capital and
Retained Earnings
Additional paid-in capital: the amount received
for the issuance of stock in excess of the par
value of the stock
Retained earnings: net income that has been
made by the corporation but not paid out as
dividends
Not necessarily available to stockholders
May be used for purchase of assets, the retirement of
debt, or other financial needs
IFRS and Stockholders Equity
Convertible bond
International accounting rules
Separated into two partsliability and stockholders
equity
U.S. accounting standards
Do not require to be recorded as a separate amount
Recorded as either liability or stockholders equity
Preferred Stock
Flexible and tailored to a companys needs
Preference to dividends before the common
stockholders
Right to the companys assets before the
common stockholders during liquidation
The dividend rate maybe stated in two ways:
Percentage of the stocks par value
Per-share amount
Preferred Stock Additional Terms
and Features
Convertible: allows preferred stock to be
exchanged for common stock
Redeemable: allows stockholders to sell stock
back to the company
Callable: Allows the firm to eliminate a class of
stock by paying the stockholders a specified
amount
Preferred Stock Additional Terms
and Features (continued)
Cumulative: the right to dividends in arrears
before the current-year dividend is distributed
Participating: Allows preferred stockholders to
share on a percentage basis in the distribution
of an abnormally large dividend
Issuance of Stock
Issuedfor cash or for noncash assets
When issued for cash:
Parvalue reported in the stock account
Amount in excess of par is reported in the Paid-In
Capital account
When exchanged for noncash items:
Recorded at the fair market value of the stock or the
assets received, whichever is most readily
determined
Example 11-1Recording Stock
Issued for Cash
Assume that on July 1, a firm issued 1,000 shares of $10 par common stock
for $15 per share
The transaction is recorded as follows:
Example 11-2Recording Stock
for Noncash Consideration
Assume that on July 1, a firm issued 500 shares of $10 par preferred stock to
acquire a building
The building has recently been appraised by an independent firm as having a
market value of $12,000
The issuance of the stock should be recorded as follows:
Treasury Stock
Issued by the firm and then repurchased but not
retired
Repurchase is recorded as a debit to Treasury Stock,
a contra-equity account
For an amount to be treated as treasury stock:
It must be the corporations own stock
It must have been issued to the stockholders at some
point
It must have been repurchased from the stockholders
It must not be retired, but must be held for some
purpose
Example 11-3Recording the
Purchase of Treasury Stock
The Stockholders Equity section of Rezin Companys balance sheet on
December 31, 2016, appears as follows:
Example 11-3Recording the Purchase
of Treasury Stock (continued)
Assume that on February 1, 2017, Rezin buys 100 of its shares as treasury
stock at $25 per share
Rezin records the following transaction at that time:
Example 11-3Recording the Purchase
of Treasury Stock (continued)
The Stockholders Equity section of Rezins balance sheet on February 1,
2017, after the purchase of the treasury stock
Retirement of Stock
Repurchase of stock with no intention of reissuing
To eliminate a particular class of stock or group of
stockholders
The general principle for retirement of stock is the
same as for treasury stock transactions
No income statement accounts are affected
Effect is reflected in the Cash account and the
Stockholders Equity accounts
Module 2 Cash Dividends, Stock
Dividends, and Stock Splits
A company might pay cash or stock dividends
Cash Dividends
Declared only if a company has sufficient cash
available and adequate retained earnings
Not an expense on the income statement
Date of declaration: cash dividends are declared
Payment date: cash dividends are paid
Date of record: dividend is paid to the
stockholders who own the stock as of this date
Dividend Payout Ratio
The annual dividend amount divided by the
annual net income
Ratio for many firms is 50% or 60% and seldom
exceeds 70%
Declaration of a Dividend
Assume that on July 1, the board of directors of Grant Company declared a
cash dividend of $7,000 to be paid on September 1
Grant reflects the declaration as a reduction of Retained Earnings and an
increase in Cash Dividend Payable as follows:
Stock Dividends
The issuance of additional shares of stock to
existing stockholders
Firms use stock dividends for several reasons
Do not require the use of cash
Reduce the market price of the stock
The lower price may make the stock more attractive
Do not represent taxable income to recipients
Example 11-7Recording a Small
Stock Dividend
Assume that Shah Companys Stockholders Equity category of the balance
sheet appears as follows as of January 1, 2016:
Stock Dividend (continued)
Assume that on January 2, 2016, Shah declares a 10% stock dividend to
common stockholders to be distributed on April 1, 2016
Assume that Shahs common stock is selling at $40 per share on that date
Therefore, the total market value of the stock dividend is $20,000 (10% of
5,000 shares outstanding, or 500 shares, times $40 per share)
Shah records the transaction on the date of declaration as follows:
Stock Dividend (continued)
The Stockholders Equity section of Shahs balance sheet on
January 2, 2016, is as follows after the declaration of the
dividend:
Declaration of a Large Stock

Dividend
Assume that instead of a 10% dividend, on January 2, 2016, Shah declares a
100% stock dividend to be distributed on April 1, 2016
The stock dividend results in 5,000 additional shares being issued and
certainly meets the definition of a large stock dividend. Shah records the
following transaction on January 2, the date of declaration:
Dividend (continued)
The accounting transaction to be recorded when the stock is actually
distributed is as follows:

Dividend (continued)
The Stockholders Equity category of Shahs balance sheet as of April 1 after
the stock dividend is as follows:
Stock Splits
The creation of additional shares of stock with a
reduction of the par value of the stock
Stock dividends
Do not affect the par value per share of the stock
Recorded
Stock Splits
Reduce the par value per share
Not recorded
Stockholders Equity accounts are not affected
Example 11-9Reporting a Stock
Split
Assume that on January 2, 2016, Shah issued a 2-for-1 stock split instead of a
stock dividend
The split results in an additional 5,000 shares of stock outstanding but is not
recorded in a formal accounting transaction
Therefore, the Stockholders Equity section of Shah Company immediately
after the stock split on January 2, 2016, is as follows:
Module 3 Analysis and Cash
Flow Issues
Comprehensive income differs from the net
income amount a company may present
Stockholders equity items affect the cash flow
statement
Statement of Stockholders Equity
Reflects the reasons for the difference between
the beginning and ending balances for all
accounts in the Stockholders Equity category of
the balance sheet
Exhibit 11-3Fun Fitnesss
Statement of Stockholders Equity,
2016
Exhibit 11-3Fun Fitnesss
Statement of Stockholders Equity,
2016 (continued)
Comprehensive Income
Totalchange in net assets from all sources
except investments by or distributions to the
owners
Important measure of a companys profitability
One-statement approach
Shown at the bottom of the income statement
Two-statement approach
Statement of Comprehensive Income must be
presented
Exhibit 11-4The Relationship between the
Income Statement and the Statement of
Comprehensive Income
Book Value Per Share
Book value per share: total stockholders equity
divided by the number of shares of common
stock outstanding
If preferred stock is present, stockholders

equity must be adjusted to reflect its liquidation
value
Calculating Book Value When
Preferred Stock Is Present
If preferred stock is present, stockholders
equity must be adjusted to reflect its liquidation
value
Exhibit 11-5Workout Wonders
Stockholders Equity Section
Exhibit 11-5Workout Wonders
Stockholders Equity Section
(continued)
The company had total stockholders equity in 2016 of $13,972 million, but
preferred stockholders had a right to $500 million in the event of liquidation
Therefore, $500 million must be deducted to calculate the rights of the
common stockholders:
$13,972 $500 = $13,472 million common stockholders equity
The number of shares of common stock outstanding for the company is 1,782
million issued less 103 million of treasury stock
Therefore, the computation of book value per share is as follows:
$13,472/1,679 = $8.02 Book Value per Share
Market Value per Share
The selling price of the stock as indicated by the
most recent transactions
For example: the listing for Nike Inc. stock on
the Internet may indicate the following:
Exhibit 11-6The Effect of
Stockholders Equity Items on the
Statement of Cash Flows
Exhibit 11-7Southwest Airlines
Co.s Partial Statement of Cash
Flows
Module 4 Sole Proprietorships
and Partnerships (Appendix)
Sole proprietorships and partnerships present
their equity accounts differently
Sole Proprietorships
Business owned by one person
The owner has an unlimited liability
Not a separate entity for legal or tax purposes
Assets and liabilities of the owner must be kept
separate from the business
Owners equity is one accountthe owners
capital account
Example 11-10Recording
Investments in a Sole Proprietorship
Assume that on January 1, 2014, Peter Tom began a new
business by investing $10,000 cash
(continued)
Assume that on July 1, 2016, Peter Tom took an auto valued at $6,000 from
the business to use as his personal auto. The transaction is recorded as
follows:
(continued)
At the end of the fiscal year, the drawing account should be closed to the
capital account as follows:
(continued)
The Income Summary account is closed to capital as follows:
(continued)
The Owners Equity section of the balance sheet for Peter Tom Company
consists of one account, the capital account, calculated as follows:
Partnership
Partnership: A business owned by two or more
individuals that has the characteristic of
unlimited liability
Characteristics of Partnerships
1. Unlimited liability
Legally, the assets of the business are not separate
from the partners personal assets
Each partner is personally liable for the debts of the
partnership
Creditors have a legal claim first to the assets of the
partnership and then to the assets of the individual
partners
(continued)
2. Limited life
Partnerships do not have a separate legal existence
and an unlimited life
The life of a partnership exists only so long as the
contract between the partners is valid
The partnership ends when a partner withdraws or
a new partner is added
A new partnership must be created for the business to
continue
(continued)
3. Not taxed as a separate entity
Partnerships are subject to the same tax features
as sole proprietorships
The partnership itself does not pay federal income
tax
The income of the partnership is treated as personal
income on each of the partners individual tax returns
and is taxed as personal income
Partnership income is subject to federal income tax
even if it is not distributed to the partners
Partnership Agreement
Specifies how much the owners will invest, what
their salaries will be, and how profits will be
shared
Investments in a Partnership
Assume that on January 1, 2016, Paige Thoms and Amy Rebec begin a
partnership named AP Company
Paige contributes $10,000 cash, and Amy contributes equipment valued at
$5,000
The accounting transaction recorded by AP Company is as follows:
Investments in a Partnership
(continued)
Assume that on April 1, 2016, each owner withdraws $2,000 of cash from AP
Company
The accounting entry is recorded as follows:
Distribution of Income
Assume that AP Company has $30,000 of net income for the period and has
established an agreement that income should be allocated evenly between
the two partners, Paige and Amy
Each capital account would be increased by $15,000
The accounting entry that AP Company records during the closing entry
process is as follows:
Another way to allocate income is to specify in the partnership agreement
that income be allocated according to a stated ratio
For example, Paige and Amy may specify that all income of AP Company
should be allocated in a 2-to-1 ratio, with Paige receiving the larger portion
An allocation method that more accurately reflects the partners input is
based on salaries, interest on invested capital, and a stated ratio
If AP Company calculated that its 2016 net income (before partner salaries)
was $30,000, income would be allocated between the partners as follows:
The accounting transaction to transfer the income to the capital accounts is
as follows:
Review
LO1 Understand the concept of stockholders equity and identify
the components of the Stockholders Equity category.
Stockholders equity consists of contributed capital from stockholders
and retained earnings from the current and prior periods of operation
that have not been paid as dividends.
Disclosure for stocks must include the number of shares authorized, issued, and
outstanding, along with the par value.
Review
LO2 Show that you understand the characteristics of common
and preferred stock and the differences between the
classes of stock.
The types of stock issued by a firm are common stock and preferred
stock.
Preferred stock receives first preference for dividends and generally provides a
more stable dividend stream to stockholders than does common stock.
Common stockholders have a claim to the residual interest in a company after all
debtors and preferred stockholders claims are satisfied. Generally, only common
stockholders are allowed voting rights.
Review
LO3 Determine the financial statement impact when stock is
issued for cash or for other consideration.
When stock is issued for cash or other consideration, the number of
outstanding shares is increased and the par value of stock is recorded
along with any amount in excess of par being recorded to the
Additional Paid-In Capital account.
When stock is sold for cash, the asset Cash is increased. When issued for noncash
consideration, other asset accounts are increased.
LO4 Describe the financial statement impact of stock treated as

treasury stock.
Treasury stock results when a corporation buys back its own stock.
Treasury stock is accounted for as a contra-equity account and is a reduction of
Review
LO5 Compute the amount of cash dividends when a firm has
issued both preferred and common stock.
The amount of a preferred stock dividend depends on the terms of
the stock agreement: cumulative, noncumulative, or cumulative and
participating.
LO6 Show that you understand the difference between cash and
stock dividends and the effect of stock dividends.
Stock dividends are given in lieu of cash dividends. Stockholders
receive shares of stock, which do not require a current use of cash
resources by the corporation.
Stock dividends do not affect total stockholders equity. They reduce retained
earnings and increase the amount of common stock and additional paid-in
capital.
Review
LO7 Determine the difference between stock dividends and
stock splits.
Both stock splits and stock dividends increase the number of shares
of stock outstanding although they are fundamentally different
transactions.
Stock splits do not require an accounting transaction to be recorded, do not
reduce the par value of the stock, and have no effect on retained earnings or
additional paid-in capital.
Review
LO8 Show that you understand the statement of stockholders
equity and comprehensive income.
The statement of stockholders equity shows how all of the equity
accounts changed for a particular accounting period or specific
periods.
Comprehensive income is based on the notion that the income
statement be inclusive of all items affecting the wealth of an entity.
The calculation of comprehensive income takes into account the
increase in net assets during a time period.
Review
LO9 Understand how investors use ratios to evaluate
Ratios used to analyze stockholders equity are designed to measure
some aspect of the value of the firm held by stockholders. Some
common measures include:
Book value per sharea measure based on balance sheet accounting amounts
recorded.
Market value per sharea measure aimed at assessing fair market value based
on the current price of stock.
Review
LO10 Explain the effects that transactions involving stockholders
equity have on the statement of cash flows.
Transactions involving stockholders equity accounts are classified as
financing activities.
Issuing stock produces cash inflows. Dividends and the retirement or
repurchase of stock produce cash outflows.
Review
LO11 Describe the important differences between the sole
proprietorship and partnership forms of organization
versus the corporate form (Appendix).
Sole proprietorships are businesses that are not incorporated and are
owned by one individual. The business entity and individual are not
distinguished from one another for legal and tax purposes.
Partnerships are also unincorporated entities but are owned by two
or more individuals. The partners and their respective shares of the
business are not distinguished from one another for legal purposes.
The partnership itself is not taxed on earnings, but individual partners
are taxed for their share.
Corporations, unlike partnerships, have some of the following
distinguishing characteristics: they are generally taxable entities and
have an unlimited life. The corporate form has been adopted by most
larger businesses and is therefore emphasized in this text.
End of Chapter 11

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Two major components or subcategories:

Total Stockholders Equity = Contributed Capital + Retained Earnings

If preferred stock is present, stockholders

LO4 Describe the financial statement impact of stock treated as

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