CHAPTER
15
Stockholders’ Equity:
Contributed
Capital
……..…………………………………………………………...
Proprietorship
Public
Partnership
Private
Corporation
Nonstock
Closed
Stock
Listed
OTC
THE CORPORATE FORM
Incorporated in
a single state
Common stock:
residual claim
Rights & privileges
• share profits & losses
• vote for directors
• share liquidation assets
• preemptive right
Limited liability
Dividends
• from retained earnings
• approved by the board
• according to preference
Preferred stock:
often a prior, but limited,
claim to earnings
CORPORATE CAPITAL
 capital stock (common or preferred)
 additional paid-in capital
 retained earnings
Par Value Stock
 par value is generally low: no contingent
liability for discount; tax benefits
No-Par Stock
 issued without a premium or discount
 some states require no-par stock to have a
minimum stated value
Lump Sum Sales
 two or more classes of stock issued together
Proportional Method
 lump sum is allocated based on relative
market value of each class
Incremental Method
 book value = market value for the class
with a known market value
 remainder of lump sum is allocated to the
class with no known market value
Example
Evans Corp. issues 10,000 bonds ($500 par, 12%) and
100,000 shares of common stock ($5 par) for $8,800,000.
Incremental Method
Assume the market rate on the bonds is 12% and the
market value of the stock is unknown.
Proportional Method
Assume the market rate on the bonds is 12% and the
market value of the stock is $40.
Bonds
Stock
Mkt Value
$5,000,000
4,000,000
Book Value
$8,800,000 x 5/9 $4,888,889
$8,800,000 x 4/9
3,911,111
Stock Issued for Noncash Consideration
 use the fair market value of the stock or the
fair market value of the consideration, which
either is clearer
 independent appraisal, if necessary
 do not use par value as a basis
 do not use book value of treasury stock as a
basis
Costs of Issuing Stock
 reduction on Additional Paid-in Capital
Reacquisition of Stock
 a form of distribution to stockholders
 tax advantages
 improves some ratios (eg. EPS)
 to block a takeover
Example
Konar Corp issues 50,000 shares of $3 par common
stock for $750,000.
The firm purchases 10,000 shares of common stock ($3
par value) for $30/share. The stock was originally issued
for $15 per share.
Cost Method
Resold 2,000 treasury shares at $32/share.
Retired 8,000 treasury shares.
PREFERRED STOCK
 cumulative preferred
 dividends in arrears must be paid before
any distribution to common stockholders
 participating preferred
 or partially participating
 convertible preferred
 to common at stockholders’ option
 callable preferred
 redeemable at option of the firm
DIVIDEND POLICY
Legal Issues
 solvency requirement
 some states limit to
retained or current
earnings
 some states limit to fair
value of net assets
Economic Issues
 liquidity
 future cash needs
Communication Issues
 smooth dividend stream (Kellogg Co.)
 disclosure of dividend policy
Cash Dividends
Date of Declaration
Date of Record
Date of Distribution
Property Dividends
 most common form: securities
 record at fair value of assets transferred
 recognize gain or loss on assets at time
dividend is declared
Liquidating Dividends
 dividends not based on retained earnings
 a return of stockholders’ investment;
reduction in paid-in capital
 must be clearly explained to stockholders
Date of Declaration
Date of Payment
Stock Dividends
 to capitalize part of earnings
 proportionate interests remained unchanged
 record at fair market value is less than 20-25%
Date of Declaration
Date of Distribution
Large Stock Dividends
 more than 20-25%
 usually reduces the market value of the stock
 record at par value of stock issued
Date of Declaration
Stock Split
 no entry recorded
 no. of shares  ; par value per share 
Exercise 15-11
Assets
Liab
S/E
Pd-in
Capital
R/E
Net
Income
Exercise 15-11 (cont.)
Assets
Liab
S/E
Pd-in
Capital
R/E
Net
Income
Extras
Assets
Recorded increase in
value of investment.
Declared a
property dividend.
Distributed the
property dividend.
Liab
S/E
Pd-in
Capital
R/E
Net
Income
Assets
Purchase of
treasury stock
Retirement of
treasury stock
Sale of common
stock above par
Liab
S/E
Pd-in
Capital
R/E
Net
Income
Dividend Preferences
Exercise 15-22
7% preferred, $10 par, 20,000 shares out
Common, $100 par, 30,000 shares out
Retained earnings
$ 200,000
3,000,000
630,000
Cumulative, participating
Prefer
One year arrears
$ 14,000
Common
Balance
$366,000
352,000
Noncumulative, nonparticipating
Prefer
Common
Noncumulative, participating beyond 10% to common
Prefer
Common
Balance
$366,000
Balance
$366,000
RETAINED EARNINGS
 income kept for use in the business
 to finance expansion
 increased by net income; decreased
by dividends
 prior period adjustments made directly
to retained earnings
 legal or contractual restrictions placed
on retained earnings should be
disclosed in the footnotes
Statement of Stockholders’ Equity
Comm
Stock
Balance, 12-31-01
Add
Pd-in
R/E
$ 80 $4,280
700
700
Unrealized Gain
30
Cash Dividends
Balance, 12-31-02
Total
SE
$ 150 $1,050 $3,000
Net Income
Repurch & retirement
of common stock
Accum
Other
Comp I
(10)
(70)
30
(130)
(130)
(40)
(120)
$ 140 $ 980 $3,530 $ 110 $4,760
Analysis
Income available to common stockholders
Rate of Return
=
on Common Stock Equity
Net Income - Preferred Dividends
Average Common SE
SE less par value of preferred stock
Payout Ratio
=
Cash Dividends to Common
Net Income - Preferred Dividends
 a profitability measure
 payout ratios have been declining for several yrs
Price Earnings
Ratio
=
Market Price of Stock
Earnings per Share
 ratio commonly used by analysts
 P/E ratios were very high for many firms in the
late 1990s
Book Value
per Share
=
Common Stockholders’ Equity
Outstanding Shares
Stockholders’ equity
- par value of preferred stock
- dividends in arrears
- preferred dividends for current year