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Two Methods of Long-Term Financing
Why issue bonds rather than stock?
Bonds Payable
Types of Bonds
Bonds Issued at Face Amount
Bonds Issued at a Discount
Bonds Issued at a Premium
Zero-Coupon Bonds
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The Concept of Present Value
Bond Redemption
Investments in Bonds
Lease Payment Obligations
Deferred Income Taxes
Financial Leverage
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Chapter
11
STOCKHOLDERS’
EQUITY:
PAID-IN CAPITAL
3
Corporations
An entity
created by law.
Existence is
separate from
owners.
Has rights and
privileges.
Ownership
can be
Privately, or
Closely, Held
Publicly Held
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Advantages of Incorporation
Limited personal
liability for
stockholders.
Transferability of
ownership.
Professional
management.
Continuity of
existence.
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Disadvantages of Incorporation
Heavy taxation.
Greater regulation.
Cost of formation.
Separation of
ownership and
management.
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Publicly Owned Corporations Face
Different Rules
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By LAW, publicly owned
corporations must:
Prepare financial statements in
accordance with GAAP.
Have their financial statement
audited by an independent
Certified Public Accountant
(CPA).
Comply with federal securities
laws.
Submit financial information
for SEC review.
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Formation of a Corporation
• Each corporation is
formed according to
the laws of the state
where it is located.
• The application for
corporate status is
called the Articles of
Incorporation.
The costs associated with
incorporation are usually
expensed immediately, but
amortized over 5 years for
tax purposes.
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Forming a Corporation
 First step is to file an application of incorporation
with the state.
 Because state laws differ, corporations often organize
in states with more favorable laws.
 More than half of the largest companies are
incorporated in Delaware.
 State grants a charter or articles of incorporation
which formally create the corporation.
 Management and board of directors prepare bylaws
which are operation rules and procedures.
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Forming a Corporation
On January 5, the firm paid the organization
costs of $8,500. This amount includes legal
fees, taxes and licenses, promotion costs, etc.
Jan. 5 Organization Costs
Cash
8 500 00
8 500 00
Paid cost of organizing the
corporation.
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Rights of Stockholders
 Voting (in person
or by proxy).
 Proportionate
Rights distribution of
dividends.
Stockholders
 Proportionate
distribution of
assets in a
liquidation.
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Rights of Stockholders
Corporate Organization Chart
Stockholder
Ultimate
ledgers
are often
controlby a
maintained
stock transfer
agent or stock
registrar.
Stockholders
Stockholders
usually meet
once a year.
Board of Directors
President
Secretary
Treasurer
Controller
Other Vice
Presidents
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Rights of Stockholders
Each unit of
ownership is
called a share of
stock.
A stock
certificate serves
as proof that a
stockholder has
purchased
shares.
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Rights of Stockholders
When the stock
is sold, the
stockholder
signs a transfer
endorsement on
the back of the
stock certificate.
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Functions of the Board of Directors
Corporate Organization Chart
Stockholders
Selected by a
vote of the
stockholders
Board of Directors
Overall
responsibility
for managing
the company.
President
Secretary
Treasurer
Controller
Other Vice
Presidents
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Functions of the Corporate Officers
Corporate Organization Chart
Contractual and legal
representation
Custodian of
funds
Stockholders
Board of Directors
Chief
Accountant
President
Secretary
Treasurer
Controller
Other Vice
Presidents
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Paid-In Capital of a Corporation
Stockholders' equity is
increased in two ways.
Contributions by
investors in exchange
for capital stock.
Retention of profits
earned by the
corporation.
Paid-in Capital
Retained Earnings
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Sources of Paid-In Capital
Authorized
Issued
Outstanding
Number of Shares
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Sources of Paid-In Capital
Major Rights that
Accompany Ownership
of a Share of Stock
1. The right to vote in matters
concerning the corporation.
2. The right to share in
distribution of earnings.
3. The right to share in assets on
liquidation.
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Authorization and Issuance of
Capital Stock
Authorized
Shares
The maximum
number of
shares of capital
stock that can be
sold to the
public.
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Authorization and Issuance of
Capital Stock
Authorized
Shares
Usually
shares are
sold
through an
underwriter.
Issued
shares are
authorized
shares of
stock that
have been
sold.
Unissued
shares are
authorized
shares of
stock that
never have
been sold.
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Authorization and Issuance of
Capital Stock
Outstanding shares are
issued shares that are
owned by
stockholders.
Authorized
Shares
Issued
Shares
Outstanding
Shares
Treasury
Shares
Unissued
Shares
Treasury shares are
issued shares that
have been reacquired
by the corporation.
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Stockholders’ Equity
Par value is an
arbitrary
amount
assigned to
each share of
stock when it is
authorized.
Market price is
the amount that
each share of
stock will sell
for in the
market.
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Classes of Stockholders
The two primary classes of paid-in capital are
common stock and preferred stock. The
primary attractiveness of preferred stocks is that
they are preferred over common as to dividends.
Money
available
for
dividends
Preferred
Stockholders
Common
Stockholders
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Classes of Stockholders
Common Stock—the basic ownership of stock
with rights to vote in election of directors,
share in distribution of earnings, and purchase
additional shares.
Preferred Stock—A class of stock with
preferential rights over common stock in
payment of dividends and company liquidation.
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Stockholders’ Equity
Common stock can be issued in three forms:
Par Value
Common
Stock
No-Par
Common
Stock
Stated Value
Common
Stock
Let’s examine
this form of
stock.
All proceeds
credited to
Common Stock
Treated like par
value common
stock
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Issuance of Par Value Stock
Record:
The cash received.
The number of shares issued × the par value
per share in the Common Stock account.
The remainder is assigned to Contributed
Capital in Excess of Par.
Prepare the journal entry to record an issuance
of 10,000 shares of $2 par value stock for $25
per share which occurred on September 1, 2003.
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Issuance of Par Value Stock
The journal entry to record an issuance of
10,000 shares of $2 par value stock for $25 per
share on September 1, 2003, should include a
credit to common stock for the par value of the
shares issued.
Date
Description
1-Sep Cash
Common Stock
Contributed Capital in
Excess of Par
Debit
Credit
250,000
20,000
230,000
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Issuance of Par Value Stock
Stockholders' Equity with Common Stock
Stockholders' Equity
Contributed capital:
Common Stock - $2 par value; 50,000 shares
authorized; 10,000 shares issued and
outstanding
$ 20,000
Contributed Capital in Excess of Par
230,000
Retained earnings
65,000
Total stockholders' equity
$ 315,000
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Preferred Stock
A separate class of stock, typically having priority over common
shares in . . .
– Dividend distributions (rate is usually stated).
– Distribution of assets in case of liquidation.
Other Features Include:
Cumulative
dividend
rights.
Usually
callable by
the company.
Normally has
no voting
rights.
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Nonparticipating Preferred Stock
A nonparticipating preferred stock is limited to a
certain amount. Assume 1,000 shares of $4
nonparticipating preferred stock and 4,000 shares
of common stock and the following:
2005
Net income
Amount retained
Amount distributed
2006
2007
$20,000 $55,000 $62,000
10,000 20,000 40,000
$10,000 $35,000 $22,000
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Nonparticipating Preferred Stock
Amount distributed $10,000 $35,000 $22,000
Preferred dividend
(1,000 shares)
4,000
4,000
4,000
Common dividend
(4,000 shares)
$6,000 $31,000 $18,000
Dividends per share:
Preferred
$ 4.00
$ 4.00 $ 4.00
Common
$ 1.50
$ 7.75 $ 4.50
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Cumulative Preferred Stock
So, preferred
dividends are two
years in arrears.
Assume 1,000 shares of $4
cumulative preferred stock
and 4,000 shares of common
stock. No dividends were
paid in 2005 and 2006.
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Cumulative Preferred Stock
On March 7, 2007, the board of directors
declares dividends of $22,000.
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Cumulative Preferred Stock
Preferred Stock Dividends
Dividends Paid in 2007
Total dividends paid,
$22,000
$4,000
2005
(In arrears)
$4,000
$4,000
2006
(In arrears)
$4,000
$4,000
$4,000
2007
Preferred
Stock
(Current dividend)
$10,000
Common
Stock
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Cumulative Preferred
Preferred Stock
Stock
Cumulative
Dividends in
arrears must be
paid before
dividends may be
paid on common
stock.
Vs.
Noncumulative
Undeclared
dividends from
current and prior
years do not have
to be paid in future
years.
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Stock Preferred as to Dividends
Example: Consider the following partial Statement of
Stockholders’ Equity.
Common stock, $50 par value; 4,000 shares
authorized, issued and outstanding
Preferred stock, 9%, $100 par value; 1,000
shares authorized, issued and outstanding
Total contributed capital
$
200,000
$
100,000
300,000
During 2002, the directors declare cash dividends of
$5,000. In year 2003, the directors declare cash
dividends of $42,000.
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Stock Preferred as to Dividends
Preferred
If Preferred Stock is Noncumulative:
Example: Consider the following partial
Year 2002 $5,000 dividends declared
$
Stockholders’ Equity.
Year 2003
Step 1: stock,
Current$50
preferred
dividend4,000 shares
$
Common
par value;
authorized,
issuedtoand
outstanding
Step 2: Remainder
common
shareholders
Preferred stock, 9%, $100 par value; 1,000
shares authorized,
issued and outstanding
If Preferred
Stock is Cumulative:
Total2002
contributed
capital declared
Year
$5,000 dividends
$
Common
Statement of
5,000 $
-
9,000
$ 200,000
$ 33,000
100,000
$ 300,000
5,000
$
-
Year 2003
Step 1: 2000,
Dividends
arrears
$ dividends
4,000
During
thein directors
declare cash
of
Step
2: Current
preferred
dividend
9,000cash
$5,000.
In year
2001,
the directors declare
Step 3: Remainderdividends
to common shareholders
$ 29,000
of $42,000.
Totals
$ 13,000 $ 29,000
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Convertible Preferred Stock
I just converted 100 shares
of preferred stock into
1,000 shares of common
stock and ended up with a
higher dividend yield!
Gee, I can’t
do that with
MY preferred
stock!
Some preferred
stock is convertible
into shares of
common stock.
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Preferred Stock
Stockholders' Equity with Common and Preferred Stock
Stockholders' Equity
Contributed capital:
Preferred Stock - $100 par value; 1,000 shares
authorized; 50 shares issued and
outstanding
$
5,000
Common Stock - $10 par value; 50,000 shares
authorized; 30,000 shares issued and
outstanding
300,000
Contributed Capital in Excess of Par
1,000
Retained earnings
65,000
Total stockholders' equity
$ 371,000
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Stock Issued for Assets Other Than
Cash
Companies sometimes issue
stock in exchange for noncash assets.
Since no cash is received,
record the transaction at the
market value of the goods or
services received.
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End of Today’s Session
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