Chapter 18
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Assets – Liabilities = Shareholders’ Equity
Net Assets
Amounts invested by shareholders
Sources of
Shareholders’
Equity
Amounts earned by corporation
Shareholders’ Equity
Paid-in Capital
Retained Earnings
Accumulated Other
Comprehensive Income
Other gains and losses not included in net income
18-2

Shareholders' Equity
Paid-in capital:
Captial stock:
Preferred stock - $100 par value; 1,000 shares
authorized; 400 shares issued and
outstanding
Common stock - $10 par value; 60,000 shares
authorized; 20,000 shares issued and
outstanding
Additional paid-in capital in excess of par value
From issuance of preferred stock
From issuance of common stock
Total paid-in capital
Retained earnings
Accumulated other comprehensive income:
Net unrealized holding gains (losses) on investments
Gains (losses) from foreign currency translation
Treasury stock (at cost)
Total shareholders' equity
$ 40,000
200,000
10,000
300,000
(35,000)
22,000
$ 550,000
121,500
(13,000)
(10,000)
$ 648,500
18-3

Accumulated other comprehensive income includes four types of gains and losses not included in net income.
Net holding gains (losses) on investments.
Gains (losses) from and amendments to postretirement benefit plans.
Gains (losses) from foreign currency translations.
Deferred gains
(losses) from derivatives.
18-4

Comprehensive income is reported periodically as it is created and also is reported as a cumulative amount.
18-5
There are 2 options for reporting comprehensive income created during the reporting period .
The accumulated amount of comprehensive income is reported as a separate item of shareholders’ equity in the balance sheet.
As an additional section of the income statement.
As a separate statement immediately following the income statement

Capital stock:

Common stock.



Preferred stock.
Paid ‐ in capital—excess of par, common.
Paid ‐ in capital—excess of par, preferred.
Share capital:

Ordinary shares.



Preference shares.
Share premium, ordinary shares.
Share premium, preference shares.
18-6








Accumulated other comprehensive income:
Net gains (losses) on investment ― AOCI.
Net gains (losses) foreign currency translation —AOCI.
Fair value adjustments not permitted.
Retained earnings.
Total shareholders’ equity.
Presented after liabilities
 Reserves:


Investment revaluation reserve.
Translation reserve.

Revaluation reserve.



Retained earnings.
Total equity.
Often presented before liabilities.
18-7

Advantages of a corporation
Continuous existence
Easy ownership transfer
Easy to raise capital
Disadvantages of a corporation
Limited liability
18-8
Double taxation
Government regulation

Not-for-profit corporations include hospitals, charities, and government agencies such as FDIC.
Publicly-held corporations whose shares are widely owned by the general public.
Privately-held corporations whose shares are owned by only a few individuals.
18-9

S Corporation


Limited liability protection of a corporation.
Maximum number of owners.
Limited liability company



Limited liability protection of a corporation.
All owners may be involved in management without losing limited liability protection.
No limit on number of owners .
Limited liability partnership

Owners are liable for their own actions but not entirely liable for actions of other partners .
18-10



Nature and location of business activities.
Number and classes of shares authorized.
18-11
Articles of incorporation are filed with the state.
State issues a corporate charter.
Shares of stock issued.
Board of directors appoint officers.
Board of directors elected by shareholders.

Right to vote.
Preemptive right to maintain percentage ownership.
18-12
Right to share in profits when dividends are declared.
Right to share in distribution of assets if company is liquidated.

Authorized shares are the maximum number of shares of capital stock that can be sold to the public.
Issued shares are authorized shares of stock that have been sold.
Unissued shares are authorized shares of stock that never have been sold.
18-13

Authorized
Shares
Outstanding shares are issued shares that are owned by stockholders.
18-14
Issued
Shares
Outstanding
Shares
Retired shares have the same status as authorized but unissued shares.
Treasury
Shares
Retired
Shares
Unissued
Shares
Treasury shares are issued shares that have been reacquired by the corporation.



Par value stock
Dollar amount per share is stated in the corporate charter.
Par value has no relationship to market value.


No-par stock
Dollar amount per share is not designated in corporate charter.
Corporations can assign a stated value per share
(treated as if par value).
Legal capital is . . .

The portion of shareholders’ equity that must be contributed to the firm when stock is issued.


The amount of capital, required by state law, that must remain invested in the business.
Refers to par value, stated value, or full amount paid for nopar stock.
18-15

Common stock is the basic voting stock of the corporation. It ranks after preferred stock for dividend and liquidation distribution. Dividends are determined by the board of directors.
Generally does not have voting rights.
Usually has a par or stated value.
Preferred
Stock
Dividend and liquidation preference over common stock.
May be convertible, callable, and/or redeemable.
18-16




Are usually stated as a percentage of the par or stated value.
May be cumulative or noncumulative .
May be partially participating , fully participating , or nonparticipating .
Unpaid dividends must be paid in full before any distributions to common stock.
Dividends in arrears are not liabilities, but the per share and aggregate amounts must be disclosed.
18-17


Preferred stock normally is reported as equity, but is reported as debt with the dividends reported in the income statement as interest expense if it is
“mandatorily redeemable” preferred stock.

Most non-mandatorily redeemable preferred stock (preference shares) also is reported as debt as well as some preference shares that aren’t redeemable. Under
IFRS (IAS No. 32), the critical feature that distinguishes a liability is if the issuer is or can be required to deliver cash (or another financial instrument) to the holder.
18-18

10,000 shares of stock are issued for $100,000 cash.
$1 Par
Value
Cash .......................................................
Common stock, par value ..............
Paid-in capital – excess of par ……
To record issue of common stock.
100,000
10,000
90,000
18-19
No Par
Value
Cash .......................................................
Common stock .............................
To record issue of common stock.
100,000
100,000
No Par,
$1 Stated
Value
Cash ................................................................... 100,000
Common stock, stated value ..................... 10,000
Paid-in capital – excess of stated value …. 90,000
To record issue of common stock.

Apply the general valuation principle by using fair value of stock given up or fair value of asset received, whichever is more clearly evident.
If market values cannot be determined, use appraised values.
18-20

More Than One Security
Issued for a Single Price


Allocate the lump-sum received based on the relative fair values of the two securities.
If only one fair value is known, allocate a portion of the lumpsum received based on that fair value and allocate the remainder to the other security.
Toys Inc. issued 5,000 shares of common stock, $10 par value, and 3,000 shares of preferred stock, $5 par value, for $450,000.
The market values of the common stock and preferred stock were $55 and $75, respectively.
Calculate the additional paid-in capital for each class of stock.
18-21

More Than One Security
Issued for a Single Price
Common Stock
Preferred Stock
Total
Market*
$ 275,000
225,000
$ 500,000
* Market Value:
Common: $55 × 5,000 shares
Preferred: $75 × 3,000 shares
**Allocation:
Common: $450,000 × 55%
Preferred: $450,000 × 45%
% Allocation** Par^
55% $ 247,500
45% 202,500
$ 50,000
15,000
100% $ 450,000 $ 65,000
Excess^^
$ 197,500
187,500
$ 385,000
^ Par Value:
Common: $10 × 5,000 shares
Preferred: $5 × 3,000 shares
^^Excess:
Common: $247,500 - $50,000 par
Preferred: $202,500 - $15,000 par
Cash ............................................................................ 450,000
Common stock, $10 par .....................................
Paid-in capital – excess of par common ………..
Preferred stock, $5 par
Paid-in capital – excess of par preferred ……….
To record issue of common and preferred stock.
50,000
197,500
15,000
187,500
18-22






Registration fees
Underwriter commissions
Printing and clerical costs
Legal and accounting fees
Promotional costs
18-23
Share issue costs reduce net proceeds from selling shares, resulting in a lower amount of additional paid-in capital.

A corporation might reacquire shares of its stock to . . .
 support the market price.



 increase earnings per share.
distribute in stock option plans.
issue as a stock dividend.
use in mergers and acquisitions.
Companies can account for the reacquired shares by retiring them or by holding them as treasury shares .
 thwart takeover attempts.
18-24

When shares are formally retired, we reduce the same capital accounts that were increased when the shares were issued – common or preferred stock, and additional paid-in capital.
 Price paid is less than issue price.
5,000 shares of $2 par value stock that were issued for $20 per share are reacquired for $17 per share.
18-25
Common stock ............................................................
Paid-in capital – excess of par common ……………....
Paid-in capital – share repurchase ……………..
Cash ………………………………………………..
To record repurchase and retirement of common stock.
10,000
90,000
15,000
85,000

 Price paid is more than issue price.
5,000 shares of $2 par value stock that were issued for $20 per share are reacquired for $25 per share.
18-26
Common stock ............................................................
Paid-in capital – excess of par common ……………….
Paid-in capital – share repurchase ……………………..
Cash ………………………………………………..
To record repurchase and retirement of common stock.
10,000
90,000
25,000
125,000
Reduce Retained Earnings if the Paid-in capital—share repurchase account balance is insufficient.

Treasury stock usually does not have:

Voting rights.

Dividend rights.

Preemptive rights.

Liquidation rights.
Treasury stock is reported as an unallocated reduction of total Shareholders’ Equity.
Acquisition of Treasury Stock

Recorded at cost to acquire.
Resale of Treasury Stock

Treasury Stock credited for cost.

Difference between cost and issuance price is (generally) recorded in paid-in capital—share repurchase.
18-27

On 5/1/12, Photos-in-a-Second reacquired 3,000 shares of its common stock at $55 per share. On 12/3/13, Photos-in-a-Second reissued 1,000 shares of the stock at $75 per share. Which of the following would be included in the 12/3/13 entry?
a. Credit Cash for $165,000.
b. Debit Treasury Stock for $75,000.
c. Credit Treasury Stock for $55,000.
d. Credit Cash for $75,000.
May 1, 2012:
Treasury stock ..............................................
Cash ...................................................
To record purchase of treasury stock.
165,000
165,000
December 3, 2013:
Cash .............................................................
Treasury stock ....................................
Paid-in capital – share repurchase ….
To record reissue of treasury stock.
75,000
55,000
20,000
18-28

18-29
The FASB and IASB are working to establish a common standard for presenting information in the financial statements, An important part of the proposal involves the organization of elements of the balance sheet, statement of comprehensive income, and statement of cash flows into a common set of classifications.
A key feature of the new format is that each of the financial statements will include classifications by operating, investing, and financing activities (similar to the current statement of cash flows).
Operating and investing activities will be included within a new category, “business” activities. Each statement also will include three additional groupings: discontinued operations, income taxes, and multicategory transactions (if needed).

Balance January 1, 2013
Net income
Cash dividends
Balance December 31, 2013
$ 106,500
25,000
(10,000)
$ 121,500


The statement of retained earnings may also contain the correction of an accounting error that occurred in the financial statements of a prior period, called a prior period adjustment .
Any restrictions on retained earnings must be disclosed in the notes to the financial statements.
18-30

Declared by board of directors.
Creates liability at declaration.
Not legally required.
Requires sufficient
Retained Earnings and
Cash.
Declaration date


Board of directors declares a $10,000 cash dividend.
Record a liability.
Declaration Date:
Retained earnings ........................................
Dividends payable ..............................
To record declaration of cash dividend.
10,000
10,000
18-31

Ex-dividend date
The first day the shares trade without the right to receive the declared dividend. (No entry)
Date of Record
Stockholders holding shares on this date will receive the dividend. (No entry)
Date of Payment
Record the dividend payment to stockholders.
Date of Payment:
Dividends payable ........................................
Cash ………………..............................
To record payment of cash dividend.
10,000
10,000
18-32




18-33

Distribution of additional shares of stock to owners.
No change in total stockholders’ equity.
No change in par values.
All stockholders retain same percentage ownership.
Stock dividend < 25%
Stock dividend > 25%
Record at current fair value of stock.
Record at par value of stock.
18-34

18-35
Retained earnings .....................................................
Common stock ………………………………….
Paid-in capital – excess of par common ……..
To record declaration and distribution of small stock dividend.
20,000,000
1,000,000
19,000,000
5,000,000 shares × 20 % = 1,000,000 shares issued × $20 = $20,000,000

Stock splits change the par value per share and the number of shares outstanding, but the total par value is unchanged, and no journal entry is required.
Assume that a corporation had 3,000 shares of
$2 par value common stock outstanding before a 2–for–1 stock split.
Common Stock Shares
Before
Split
3,000
Par Value per Share
Total Par Value
$ 2.00
$ 6,000
After
Split
6,000
$ 1.00
$ 6,000
Increase
Decrease
No
Change
18-36

Matrix Inc. declares and distributes a 2-for-1 stock split effected in the form of a 100% stock dividend. The company has 1,000,000, $1 par value common stock outstanding. The stock is trading in the open market for
$14 per share. The per share par value of the shares is not to be changed.
18-37
Paid-in capital – excess of par common ….................
Common stock ……………..…………………….
To record declaration and distribution of 2-for-1 stock split effected in the form of a 100% stock dividend.
1,000,000
1,000,000

Purpose
To allow a company undergoing financial difficulty, but with favorable future prospects, to get a fresh start by writing down inflated assets and eliminating an accumulated balance in retained earnings.



Procedures
Assets and liabilities are revalued to reflect market values, with corresponding debits and credits to retained earnings.
The debit balance in retained earnings is eliminated first against additional paid-in capital, and then, if necessary, against common stock.
Retained earnings is dated to indicate when the new accumulation of earnings began.
18-38

Emerson-Walsch Corporation has incurred losses for several years. The board of directors voted to implement a quasi reorganization, subject to shareholder approval.
The balance sheet prior to restatement, in millions, follows :
Cash
Receivables
Inventory
Property, plant, and equipment (net)
Total assets
Liabilities
Common stock (800 million shares @$1)
Additional paid-in capital
Retained earnings (deficit)
Total liabilities and equity
(millions)
$ 75
200
375
400
$ 1,050
$ 400
800
150
(300)
$ 1,050
Fair values:
Inventory =
$300,000,000 and Property, plant, and equipment =
$225,000,000.
Let’s prepare the journal entries necessary for the quasi reorganization.
18-39

18-40
To revalue assets
Retained earnings …………………………..................
250,000,000
Inventory ………………………………………….
Property, plant, & equipment ……………………
To record reduction to fair value of assets.
75,000,000
175,000,000
To eliminate the deficit in retained earnings
Paid-in capital – excess of par common ……..............
150,000,000
Common stock ………….……………………………….
400,000,000
Retained earnings ………………..………………
To eliminate the deficit in retained earnings.
550,000,000
$300,000,000 + $250,000,000

Balance sheet immediately after restatement.
Cash
Receivables
Inventory
Property, plant, and equipment (net)
Total assets
Liabilities
Common stock (800 million shares @$.50)
Additional paid-in capital
Retained earnings
Total liabilities and equity
(millions)
$ 75
200
300
225
$ 800
$ 400
400
0
0
$ 800
18-41

18-42