Act 211, Chapter 10

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Chapter 10:

Chapter 10 Stockholders’ Equity McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Stockholders’ Equity:

Stockholders’ Equity Stockholders’ Equity = Assets - Liabilities Primary Sections of Stockholders’ Equity Paid-in capital Retained Earnings Treasury Stock Amount stockholders have invested in the corporation Amount of earnings the corporation has retained Corporation’s own stock that it has reacquired 10- 2

Part A:

Part A Invested (Paid-In) Capital 10- 3

LO1 Corporations:

LO1 Corporations Articles of incorporation ( or corporate charter ) describe the nature of the firm’s business activities the shares to be issued the initial board of directors Corporation’s stockholders control the corporation - By voting their shares, they determine the makeup of the board of directors - which in turn appoints the management to run the corporation . 10- 4

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Stockholders Chairman and Board of Directors President and Chief Executive Officer General Counsel and Secretary Vice President Marketing Vice President Finance/Chief Financial Officer Vice President Operations Vice President Human Resources Treasurer Controller The Corporate Form of Organization

Stages of Equity Financing:

Stages of Equity Financing The progression leading to a public offering might include some or all of these steps: Investment by the founders of the business. Investment by friends and family of the founders. Outside investment by “angel” investors (wealthy individuals in the business community willing to provide investment funds) and venture capital firms (provide additional financing for a percentage ownership in the corporation). Initial public offering (IPO) , the first time a corporation issues stock to the public. 10- 6

Public or Private:

Public or Private Stocks trade on a stock exchanges such as NYSE, AMEX, NASDAQ; or by over-the-counter (OTC) trading. Regulated by the Securities and Exchange Commission (SEC) Examples – Wal-Mart, Microsoft, Intel Does not allow investment by the general public and has fewer stockholders Not regulated by the Securities and Exchange Commission (SEC) and do not need to file financial statements with it Examples - Cargill (agricultural commodities) Koch Industries (oil and gas), Chrysler (cars) Corporations may be either public or private Public Private 10- 8

Stockholder Rights:

Stockholder Rights Whether public or private, stockholders are the owners of the corporation and have certain rights: Right to vote Right to receive dividends Right to share in distribution of assets Preemptive right – allows a stockholder to maintain his or her percentage share of ownership. 10- 10

Advantages and Disadvantages of a Corporation:

Advantages and Disadvantages of a Corporation Additional taxes More paperwork Limited liability Ability to raise capital Lack of mutual agency Advantages Disadvantages 10- 11

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LO2 Common Stock:

LO2 Common Stock Stock “Nature” Definition Authorized Shares available to sell ( issued and unissued) Issued Shares actually sold ( includes treasury stock) Outstanding Shares held by investors ( excludes treasury stock ) Authorized – Issued = Unissued Issued – Treasury Stock = Outstanding If a corporation has only one kind of stock, it usually is labeled as common stock. 10- 14

Par Value:

Par Value The legal capital per share of stock that’s assigned when the corporation is first established Has no significant meaning today. Has no relationship to the market value of the common stock NO PAR VALUE Common stock that has not been assigned a par value STATED VALUE Treated in the same manner as par value shares 10- 15

Accounting for Common Stock Issues:

Accounting for Common Stock Issues When a corporation receives cash from issuing common stock, it debits cash. If it issues no-par value stock , the corporation credits the equity account entitled common stock. Cash (1,000 shares x $30) 30,000 Common Stock 30,000 (Issues no-par value common stock at $30 per share) The entry changes slightly if the corporation issues par value stock rather than no-par value stock. In that case, we credit common stock and additional paid-in capital. Cash (1,000 shares x $30) 30,000 Common Stock (1,000 shares x $0.01) 10 Additional Paid-in Capital (difference) 29,990 (Issue $0.01 par value common stock at $30 per share) 10- 16

LO3 Preferred Stock:

LO3 Preferred Stock Usually have first rights to a specified amount of Dividends . Receive preference over common stockholders in the distribution of assets in the event the corporation is dissolved. Factor Common Stock Preferred Stock Bonds Voting rights Yes Usually No No Risk to the investor Highest Middle Lowest Expected return to the investor Highest Middle Lowest Risk of contract violations Lowest Middle Highest Preference for payments Lowest Middle Highest Tax deductibility of payments No Usually No Yes Comparison of common stock, preferred stock, and bonds 10- 17

Accounting for Preferred Stock Issues:

Accounting for Preferred Stock Issues The entries to record the issuance of preferred stock are similar to those for the issue of common stock Cash (1,000 shares x $40) 40,000 Preferred Stock (1,000 shares x $30) 30,000 Additional Paid-in Capital 10,000 (Issue $30 par value preferred stock at $40 per share) 10- 18

Features of Preferred Stock:

Features of Preferred Stock Flexibility allowed in its contractual provisions Convertible Redeemable Cumulative Shares can be exchanged for common stock Shares can be returned to the corporation at a fixed price Shares receive priority for future dividends, if dividends are not paid in a given year 10- 19

LO4 Treasury Stock:

LO4 Treasury Stock Why corporations repurchase their stock To boost under-priced stock. To distribute surplus cash without paying dividends. To boost earnings per share. To create supply of shares for stock-based compensation plans. Occasionally to prevent a hostile takeover A corporation’s own stock that it has reacquired 10- 20

Accounting for Treasury Stock:

Accounting for Treasury Stock Treasury Stock (100 shares x $30) 3,000 Cash 3,000 (Repurchase treasury stock for $30 per share) Cash (100 shares x $35) 3,500 Treasury Stock (100 shares x $30) 3,000 Additional Paid-in Capital (difference) 500 (Reissue treasury stock for $35 per share) Cost Reissue price Treasury stock is reported as a contra-equity (negative equity account). When a corporation repurchases its own stock, it increases, or debits treasury stock and vice versa when it sells. 10- 22

Accounting for Treasury Stock:

Accounting for Treasury Stock Cash (100 x $25) 2,500 Additional Paid-in Capital (100 x $5) 500 Treasury Stock (100 x $30) 3,000 (Sell treasury stock for $25 per share) Cost Reissue price What if the stock price goes down and we reissue the treasury stock for less than we paid to buy back the shares? 10- 23

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Sample Stockholder’s Equity Section

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Part B:

Part B Earned Capital 10- 26

LO5 Retained Earnings and Dividends:

LO5 Retained Earnings and Dividends RETAINED EARNINGS Represents the earnings retained in the corporation – earnings not paid out as dividends to stockholders. Equals all net income, less all dividends, since the corporation began . Has a normal credit balance consistent with other stockholders’ equity accounts. If losses exceed income since the corporation began, retained earnings will have a debit balance and is called an accumulated deficit . 10- 27

Amazon’s Stockholder’s Equity (2008-2009):

Amazon’s Stockholder’s Equity ( 2008-2009)

Dividends:

Dividends Distributions by a corporation to its stockholders Not paid on treasury shares repurchased by the corporation Investors pay careful attention to cash dividends DECLARATION DATE Date on which dividend is declared RECORD DATE Date on which the registered owners of stock are determined PAYMENT DATE Date on which the cash dividend is paid 10- 29

Dividends:

Dividends Lets consider the following dividend example A corporation declares a $0.25 per share dividend on its 2,000 outstanding shares March 15 (declaration date) Retained Earnings (2,000 shares x $0.25) 500 Dividends Payable 500 (Declaration of cash dividends) April 15 (payment date) Dividends Payable (2,000 shares x $0.25) 500 Cash 500 (Payment of cash dividends) March 31 (No entry for Record date) 10- 30

Stock Preferred as to Dividends:

Radford University - M. Chatham - Financial Accounting 211 31 Example: Consider the following partial Statement of Stockholders’ Equity. During 2012 , the directors declare cash dividends of $5,000 . In year 2013 , the directors declare cash dividends of $42,000 . Stock Preferred as to Dividends

Stock Preferred as to Dividends:

Radford University - M. Chatham - Financial Accounting 211 32 Example: Consider the following partial Statement of Stockholders’ Equity. During 2002, the directors declare cash dividends of $5,000. In year 2003, the directors declare cash dividends of $42,000. Stock Preferred as to Dividends

LO6 Stock Dividends and Stock Splits:

LO6 Stock Dividends and Stock Splits Sometimes, corporations distribute to shareholders additional shares of the companies’ own stock rather than cash. These are known as stock dividends or stock splits depending on the size of the stock distribution. You own 100 shares and assume a You will get 10% stock dividend 10 additional shares 20% stock dividend 20 additional shares 100% stock dividend 100 additional shares Small stock dividend Large stock dividend 10- 33

Stock Dividends:

Since the corporation’s shares double following a 100% stock dividend , we make an entry to reflect the increase in the par value of the common shares (assuming 1000 shares outstanding). Stock Dividends Retained Earnings (1,000 shares x $0.01 ) 10 Common Stock 10 (100% stock dividend, large stock dividend) Small stock dividends (25% or less stock dividend) are recorded by debiting retained earnings for the market value (assumed $30 here), rather than the par value, per share. Retained Earnings (1,000 x 10% x $30 ) 3,000 Common Stock (1,000 x 10% x $0.01) 1 Additional Paid-In Capital (difference) 2,999 (10% stock dividend, small stock dividend) 10- 34

Stock Splits:

Stock Splits A stock distribution of 25% or higher, although it’s technically a “large” stock dividend, is more often referred to as a stock split. A 100% stock dividend is effectively the same as a 2-for-1 stock split, although the accounting for a 100% stock dividend and a 2-for-1 stock split differs. Make no journal entry to record a stock split . After a 2-for-1 stock split, the common stock account balance (total par) represents twice as many shares and the par value per share is reduced by one-half. 10- 35

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Part C:

Part C Reporting and Analyzing Stockholders’ Equity 10- 37

LO7 Stockholders’ Equity:

LO7 Stockholders’ Equity 10- 38

Statement of Stockholders’ Equity:

Statement of Stockholders’ Equity Summarizes the changes in the balance in each stockholders’ equity account over a period of time . 10- 39

LO8 Equity Analysis:

LO8 Equity Analysis Equity Analysis Return on Equity Return on the Market Value of Equity Price-Earnings Ratio Earnings Per Share 10- 40

Return on Equity:

Return on Equity Measures the ability of company management to generate earnings from the resources that owners provide. Return on equity = Net income Average stockholders’ equity 10- 41

Return on Market Value of Equity:

Return on Market Value of Equity To supplement the return on equity ratio, analysts often relate earnings to the market value of equity ( *calculated as the ending stock price times the number of shares outstanding ). Return on the market value of equity = Net income Market value of equity* 10- 42

Earnings Per Share:

Earnings Per Share Earnings per share = Net income Average common shares outstanding during the period Measures the net income earned per share of common stock. Useful in evaluating the earnings performance of a company over time. Not useful in comparing earnings performance across companies. 10- 43

Price-Earnings Ratio (PE Ratio):

Price-Earnings Ratio (PE Ratio) A high PE ratio indicates investors expect future earnings to be higher. A low PE ratio indicates investors lack of confidence in future earnings growth. Price-Earnings Ratio = Stock price Earnings per share GROWTH STOCKS Priced high in relation to current earnings VALUE STOCKS Priced low in relation to current earnings 10- 44

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Good Luck on the Chapter 10 Homework!

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