Equity Financing - Learning
Objectives
1.
2.
3.
4.
5.
6.
7.
Identify the rights associated with ownership of common
and preferred stock.
Record the issuance of stock for cash, on a subscription
basis, and in exchange for noncash assets or for services.
Use both the cost and par value methods to account for
stock repurchases.
Account for the issuance of stock rights and stock warrants.
Explain the difference between the intrinsic value and fair
value methods, and use both in accounting for a fixed stock
option plan.
Distinguish between stock conversions that require a
reduction in retained earnings and those that do not.
List the factors that impact the retained earnings balance.
1
Learning Objectives
8. Properly record cash dividends, property dividends,
small and large stock dividends, and stock splits.
9. Explain the background of unrealized gains and
losses recorded as direct equity adjustments, and list
the major types of equity reserves founds in foreign
balance sheets.
10.Prepare a statement of changes in stockholders’
equity.
2
Common Stock
The owners of common
stock of a corporation can be
thought of as the true
owners of the business.
Unless restricted by terms
of the articles of
incorporation, the common
stockholder has certain
basic rights.
3
Common Stock
 The right to vote in the election of
directors and in the determination of
certain corporate polices such as the
management compensation plan or
major corporate acquisitions.
 The right to maintain one’s
proportional interest in the corporation
through purchase of additional
common stock if and when it is issued.
4
5
Common Stock
Rex Corporation issued 5,000 shares of
common stock with a par value of $1 on
April 1, 2005, for $30,000 cash.
Apr. 1 Cash
Common Stock
Additional Paid-In
Capital
30,000
5,000
at25,000
Par Value
Preferred Stock
The title
“preferred” stock is
somewhat
misleading.
Preferred isn’t
better; it’s
different.
6
Preferred Stock
The rights of ownership given up
by preferred stockholders:
• Voting: In most cases, preferred stockholders
are not allowed to vote for the board of
directors.
• Sharing in success: The cash dividends
received by preferred stockholders are usually
fixed in amount. If the company does
exceptionally well, preferred stockholders do
not get to share in the success.
7
Preferred Stock
The protection enjoyed by
preferred stockholders is:
• Cash dividend preference: Preferred
stockholders are entitled to receive their full
cash dividend before any cash dividend can
be issued to common stockholders.
• Liquidation preference: If the company goes
bankrupt, preferred stockholders are entitled
to have their investment repaid in full, before
common stockholders receive anything.
8
Preferred Stock
Cumulative
Has the right to receive
accumulated dividends before
any dividends may be paid to
common stockholders.
NonCumulative
Has no right to “passed”
dividends.
Participating
Has claim to a portion of
common dividends after
receiving preferred dividends.
9
Preferred Stock
Convertible
Callable
Redeemable
10
Permits the holder to exchange
preferred stock for common
stock.
Permits the issuing company
to redeem the preferred stock.
Permits the holder to redeem the
stock—usually with some
restrictions.
Preferred Stock
Dividends on cumulative
preferred stock that are passed
are referred to as dividends in
arrears.
And… dividends are
not a liability until
declared by the board
of directors.
11
Preferred Stock
Participating
preferred stock issues
provide for additional
dividends to be paid to
preferred stockholders
after dividends of a
specified amount are
paid to common
stockholders.
Callable preferred stock
is preferred stock that is
redeemable at the option
of the corporation.
Redeemable preferred
stock is preferred stock
that is redeemable at the
option of the
stockholder.
12
Capital Stock Issued for Cash
Goode Corporation issued 4,000
shares of $1 par common stock on
April 1, 2005, for $45,000 cash.
Apr. 1 Cash
Common Stock
Paid-In Capital in
Excess of Par
45,000
4,000
41,000
13
Capital Stock Issued for Cash
On April 1, 2005, Goode
Corporation issued 4,000 shares of
no-par common stock without a
stated value for $45,000 cash.
Apr. 1 Cash
Common Stock
45,000
45,000
14
Capital Stock Sold on
Subscription
On November 1, 2005, a firm received
subscriptions for 5,000 shares of $1 par
common at $12.50 per share with 50%
down, balance due in 60 days.
Nov. 1 Common Stock Subscription
Receivable
62,500
Common Stock Subscribed
5,000
Paid-In Capital in Excess
of Par
57,500
15
Capital Stock Sold on
Subscription
16
On November 1, 2005, a firm received
subscriptions for 5,000 shares of $1 par
common at $12.50 per share with 50%
down, balance due in 60 days.
Nov. 1 Cash
Common Stock
Subscription Receivable
31,250
31,250
Capital Stock Sold on
Subscription
17
On December 9, received balance due on
one-half of subscribers and issued stock
to fully paid subscribers, 2,500 shares.
Dec. 9 Cash
Common Stock
Subscription Receivable
9 Common stock Subscribed
Common Stock
15,625
15,625
2,500
2,500
Stock Issued for Consideration
Other Than Cash
AC Company issues 200 shares of $0.50
par value common stock in return for
land. The company’s stock is currently
selling for $50 per share.
Dec. 5 Land
Common Stock
Paid-In Capital in Excess
of Par
10,000
100
9,900
18
Stock Issued for Consideration
Other Than Cash
Assume that the land has a readily
determinable market price of $12,000,
but AC Company’s common stock has
no established fair market value.
Dec. 5 Land
Common Stock
Paid-In Capital in Excess
of Par
12,000
100
11,900
19
20
Stock Repurchases
Companies acquired their own stock to…
1.
2.
3.
4.
6.
7.
Provide shares for incentive compensation and employee
savings plans.
Obtain shares needed to satisfy requests by holders of
convertible securities.
Reduce the amount of equity relative to the amount of debt.
Invest excess cash temporarily.
Remove some shares from the open market in order to protect
against a hostile takeover.
Improve per-share earnings by reducing the number of shares
outstanding and returning inefficiently used assets to
shareholders.
Display confidence that the stock is currently undervalued by
the market.
Treasury Stock
• Stock issued by a corporation but subsequently
reacquired by and held in the name of the corporation
and held for possible future reissuance or retirement.
• Reported as a contra-equity account, not as an asset.
• Does not create a gain or loss on reacquisition,
reissuance, or retirement.
• May decrease Retained Earnings, but cannot
increase it.
• There are two methods to account for treasury stock
transactions: (1) Cost method and (2) Par value
method
21
22
Treasury Stock
Issued 10,000, $1 par value shares at $15 per share
Cost Method
Cash
Common Stock.
Paid-In Capital in
Excess of Par
150,000
10,000
140,000
Par Value Method
Cash
Common Stock.
Paid-In Capital in
Excess of Par
150,000
10,000
140,000
23
Treasury Stock
Reacquired 1,000 shares at $40 per share.
Cost Method
Treasury Stock
Cash
40,000
40,000
Par Value Method
Treasury Stock
1,000
Paid-In Capital in Excess of Par 14,000
Retained Earnings
25,000
Cash
The balance
40,000
24
Treasury Stock
Sold 200 shares of treasury stock at $50 per share.
Cost Method
Cash
Treasury Stock
Paid-In Capital from
Treasury Stock
10,000
8,000
2,000
Par Value Method
Cash
Treasury Stock
Paid-In Capital in Excess
of Par
10,000
200
9,800
25
Treasury Stock
Sold 500 shares of treasury stock at $34 per share.
Cost Method
Cash
Paid-In Capital from Treasury
Stock
Retained Earnings
Treasury Stock
17,000
2,000
1,000
20,000
Par Value Method
Cash
Treasury Stock
Paid-In Capital in Excess
of Par
17,000
500
16,500
26
Treasury Stock
Retired remaining 300 shares of treasury stock.
Cost Method
Common Stock
300
Paid-In Capital in Excess of Par 4,200
Retained Earnings
7,500
Treasury Stock
12,000
Par Value Method
Common Stock
Treasury Stock
300
300
Stock Rights, Warrants,
and Options
 Stock rights—Issued to existing
shareholders to permit them to maintain
their proportionate ownership interests
when new shares are to be issued.
 Stock warrants—Sold by the corporation
for cash, generally in conjunction with the
issuance of another security.
 Stock options—Granted to officers or
employees, usually as part of a
compensation plan.
27
Stock Warrants
Stewart Co. sells 1,000 shares of $50 par
preferred stock for $58 per share. Stewart Co.
gives the purchaser detachable warrants
enabling the holders to subscribe to 1,000
shares of $2 par common stock for $25 per
share. Immediately following the issuance of
the stock, the warrants are selling for $3, and
the fair market value of a preferred share
without the warrant attached is $57.
28
Stock Warrants
Value
Total
assigned to = issue
warrants
price
Market value of warrants
x
Market value Market
of security + value of
without
warrants
warrants
Value
$3
= $2,900
assigned to = $58,000 x
$57 + $3
warrants
29
30
Stock Warrants
The entry on Stewart’s book to record
the sale of the preferred stock with
detachable warrants is:
Cash
Preferred Stock, $50 par
Paid-In Capital in Excess of
Par--Preferred Stock
Common Stock Warrants
58,000
50,000
5,100
2,900
31
Stock Warrants
If the warrants are exercised, the entry to
record the issuance of common stock is:
Common Stock Warrants
Cash
Common Stock, $2 par
Paid-In Capital in Excess of
Par—Common Stock
2,900
25,000
2,000
25,900
Stock Warrants
32
If these warrants were
allowed to expired, what
entry would be required?
Common Stock Warrants 2,900
Paid-In Capital from
Expired Warrants
2,900
Stock-Based Compensation
On January 1, 2003, the board of
directors of Neff Company
authorize the grant of 10,000 stock
options. Each option permits the
purchase of one share of Neff
common stock at $50 per share.
The options vest or becomes
exercisable on Jan 1, 2006.
33
Stock-Based Compensation
The
Oncompany
January 1,estimates
2003, thea grant
boarddate
of
value
directors
of $10
of Neff
for each
Company
of the
authorize
employeethe
stock
grant
options.
of 10,000
Thestock
total
fair
options.
value Each
of theoption
options
permits
granted
theis
$100,000.
purchase of
Compensation
one share of cost
Neffis
common
allocatedstock
over three
at $50years
per share.
from
January 1, 2003 (the grant date) to
January 1, 2006 (the vesting date).
34
35
Stock-Based Compensation (Fair Value Method)*
2003
Dec. 31 Compensation Expense
Paid-In Capital from
Stock Options
33,333
33,333
$100,000 ÷ 3
Similar entries would be
made in 2004 and 2005.
* There is also the Intrinsic Value Method, in which case
these entries would not be made.
36
Stock-Based Compensation (Fair Value Method)*
On December 31, 2006, all 10,000 of the
options are exercised to purchase Neff’s nopar common stock.
2006
Dec. 31 Cash
500,000
Paid-In Capital from Stock
Options
100,000
Common Stock (no par)
600,000
* Under the intrinsic value method, the entry would have been:
2006
Dec. 31
Cash 500,000
Common Stock (no par)
500,000
37
Stock-Based Compensation (Fair Value Method)*
If the options had been allowed to expired,
the following entry would have been
necessary on December 31, 2006:
2006
Dec. 31 Paid-In Capital from Stock
Options
Paid-In Capital from
Expired Options
100,000
100,000
* The entry would have been the same under the Intrinsic Value Method.
38
Stock Conversions
Case 1
On December 31, 2005, 1,000 shares of preferred
stock (par $50 and original selling price of $60) are
exchanged for 4,000 shares of common stock (par $1)
2005
Dec. 31 Preferred Stock, $50 par
50,000
Paid-In Capital in Excess of
Par—Preferred
10,000
Common Stock
Paid-In Capital in Excess
of Par—Common
4,000
56,000
39
Stock Conversions
Case 2
On December 31, 2005, 1,000 shares of preferred
stock (par $50 and original selling price of $60)
are exchanged for 4,000 shares of common stock
(par $20)
2005
Dec. 31 Preferred Stock, $50 par
Paid-In Capital in Excess of
Par—Preferred
Retained Earnings
Common Stock
50,000
10,000
20,000
80,000
Accounting for Dividends
• Declaration date: The date the corporation’s
board of directors formally declares a
dividend will be paid.
• Date of record: The date on which
stockholders of record are identified as those
who will receive a dividend.
• Date of payment: The date when the
dividend is actually distributed to
stockholders.
40
41
Cash Dividend
ABC Corporation declares a $100,000
dividend; the following journal entries should
be made:
Declaration Date
Dividends (or Retained Earnings) 100,000
Dividends Payable
100,000
Payment Date
Dividends Payable
Cash
100,000
100,000
Property Dividend
It is a distribution to
stockholders that is
payable in some asset
other than cash.
42
Property Dividend
Bigley Corporation owns 100,000 shares
in Tri-State Oil Co, carrying value
$2,700,000, current market value
$3,000,000, or $30 per share. There are
1,000,000 shares of Bigley stock
outstanding. A dividend of 1/10 of a
share of Tri-State Oil Co. is declared for
each share of Bigley stock outstanding.
43
Property Dividend
44
Declaration of Dividend
Dividend (or Retained Earnings) 3,000,000
Property Dividends Payable
2,700,000
Gain on Distribution of Property
Dividend
300,000
Payment of Dividend
Property Dividends Payable
2,700,000
Investment in Tri-State Oil Co.
2,700,000
45
Stock Dividends
• Small
– Less than 20-25% of the outstanding
shares.
– Debit Retained Earnings for the (post)
MARKET value of the shares.
• Large
– Greater than 20-25% of the shares
outstanding.
– Debit Retained Earnings for the PAR
value of the shares.
Example 1: Stock Dividend
• Assume the following about Gean, Inc.:
– Common stock ($2 par, 10,000
shares outstanding)
$20,000
– Additional paid-in capital
$24,200
– Retained earnings
$12,500
– Stock dividend declared
1,500 shares
– Market price of stock
$10/share
Is this a large or small stock dividend?..Because 1,500 shares represent
15% of the outstanding stock, it is a small stock dividend.
46
Example 1: Stock Dividend
Declaration Date
Retained Earnings
15,000
Stock Dividends Distributable
3,000
Paid-In Capital in Excess of Par
12,000
Issuance Date
Stock Dividends Distributable
3,000
Common Stock
3,000
47
Example 2: Stock Dividend
• Assume the following about Gimli’s Corp.:
– Common Stock ($5 par, 20,000
shares outstanding)
$100,000
– Additional Paid-In Capital
$100,000
– Retained Earnings
$52,000
– Stock Dividend Declared 10,000 shares
– Market Price of Stock
$20/share
Is this a large
smalldividend
stock dividend?
50% =orlarge
48
Example 2: Stock Dividend
Declaration Date
Retained Earnings
50,000
Stock Dividends Distributable
50,000
Issuance Date
Stock Dividends Distributable
50,000
Common Stock
50,000
49
Unrealized Gains and Losses on
Available-For-Sale Securities
Available-for-sale securities are
those that were not purchased
with the immediate intention to
resell…
…but the company also
doesn’t necessarily plan to
hold these securities forever.
50
The impact of other income-related
equity items
Kendell had net income of $1,350. Other
items that impacted net income are:
Unrealized gain (loss) on availablefor-sale securities
$100
(Increase) Decrease in minimum
pension liability
(60 )
Unrealized gain (loss) on derivative
instruments
(20 )
Foreign currency translation
adjustment, increase (decrease) in
stockholders’ equity
300
51
Unrealized Gains and Losses on
Available-For-Sale Securities
Net income
$1,350
Other comprehensive income:
Unrealized gain on available-forsale securities
60
Increase in minimum pension liability
(36 )
Unrealized loss on derivative
instruments
(12 )
Foreign current transaction
adjustments
180
Comprehensive income
$1,542
52
Liquidating Dividend
A liquidating dividend is a distribution
representing a return to stockholders of a
portion of contributed capital.
See page 672 of text.
53
Disclosures Related to the
Equity Section
Capital stock may be:
 Authorized but unissued.
 Subscribed for and held for issuance
pending receipt of cash for the full amount
of the subscription price.
 Outstanding in the hands of stockholders.
 Reacquired and held by the corporation for
subsequent reissuance.
 Canceled by appropriate corporate action.
54