Stockholders’ Equity
I.
II.
General
a. Also known as
i. Shareholders’ equity
ii. Owners’ equity
b. The Owners’ claim to the net assets (assets minus liabilities) of a
corporation.
c. Presented on the balance sheet as the last major section, following
liabilities, with 5 major components:
i. Capital stock (legal capital)
ii. Additional paid in capital
iii. Retained earnings or deficit
iv. Accumulated other comprehensive income
v. Treasury stock
Capital Stock (Legal Capital): amount of capital that must be retained by the
corporation for the protection of creditors. Par or stated value of both
preferred and common stock is legal capital and is frequently referred to as
capital stock.
a. Par Value—minimum price the stock is to be issued for. Any excess of
the actual amount received over the par or stated value is accounted for as
additional paid-in-capital.
b. Authorized, Issued, and Outstanding
i. Authorized: the types and amounts of stock that it may legally
issue
ii. Issued: authorized stock that has been sold to shareholders
iii. Outstanding: the amount of issued stock currently in the hands of
shareholders (not the corporation itself, treasury stock).
c. Common Stock—the basic ownership interests in a corporation
i. Common shareholders bear the ultimate risk of loss and receive the
ultimate benefits of success.
ii. Commons shareholders generally control management, have the
right to vote, have the right to share in earnings, have a right to a
proportionate share of any additional share of any additional
common stock issued, and the right to share in assets upon
liquidation after paying creditors and preferred shareholders.
iii. Book value per common share: the amount that common
shareholders would receive for each share if all assets were sold at
their book values and creditors were paid.
1. Book value per common share = common shareholders’
equity/common shares outstanding
2. Common shareholders’ Equity Formula:
Total
shareholders’ equity minus preferred stock outstanding
minus cumulative preferred dividends in arrears.
d. Preferred Stock—an equity security with preferences and features not
associated with common stock.
III.
IV.
i. Cumulative preferred stock: all or part of the preferred dividend
not paid in any year accumulates and must be paid in the future
before dividends can be paid to common shareholders. The
accumulated amount is referred to as dividends in arrears (not a
liability but parenthetical or footnote disclosure should be made).
ii. Non-cumulative preferred stock: dividends not paid in any year do
not accumulate.
iii. Participating Preferred Stock: preferred shareholders share with
common shareholders in dividends in excess of a specific amount.
The participation may be full or partial.
iv. Non-participating Preferred Stock: preferred shareholders are
limited to the dividends provided by their preference. They do not
share in excess dividends.
v. Preference upon liquidation:
a preference to assets upon
liquidation of the entity.
vi. Convertible preferred stock: may be exchanged for common stock
at a specified conversion rate.
vii. Callable Preferred Stock: may be repurchased at a specific price at
the option of the issuing corporation.
Additional Paid-In Capital: contributed capital in excess of par or stated
value. It can also arise from other different types of transactions such as sale
of treasury stock at a gain, donated assets, quasi-reorganization, the issuance
of liquidating dividends, etc.
Retained Earnings or Deficit: accumulated earnings or losses during the life
of the corporation that have not been paid out as dividends.
a. Classification of Retained Earning
i. Appropriated: restricted retained earnings; not available to pay
dividends because they have been restricted for legal or contractual
reasons or as a discretionary act of management for specific
contingency purposes
ii. Unappropriated: retained earnings without restriction that can be
paid to shareholders
iii. Entry to appropriate retained earnings:
b. Quasi-Reorganization:
aka corporate readjustment: an accounting
adjustment (not a legal reorganization) that revises the capital structure of
a corporation as though it had been legally reorganized. It allows a
corporation with a significant deficit in retained earnings to eliminate that
deficit and have a fresh start.
i. Purpose: restate overvalued assets to their lower fair values (and
thus reduce future depreciation) and to eliminate a retained
earnings deficit (and thus facilitate dividends).
ii. Procedures
1. Revalue assets to current fair values and liabilities to their
present values. (No net increase in asset value is permitted,
and the write-down is charged directly to retained earnings,
thus increasing the deficit temporarily).
V.
VI.
2. Bring retained earnings to zero (eliminate the deficit)
against paid-in-capital. (If additional paid-in-capital is
insufficient to absorb the deficit, more additional paid-incapital can be created by reducing the par or stated value of
the stock, thus reducing capital stock).
3. Following a quasi-reorganization, retained earnings on the
balance sheet must be dated to show the date of the
adjustment, and that date must continue to be disclosed
until such time as it is insignificant (3-10 years).
Accumulated Other Comprehensive Income: components include gains and
losses on foreign currency translations, adjustments to minimum pension
liability, unrealized gains and losses on available-for sale securities, and gains
and losses on the effective portion of cash flow hedges. These components
are not included in determining net income, and therefore do not enter
retained earnings. Rather, they are recognized in the period in which they
occur and are combined with net income to determine comprehensive income.
Total accumulated other comprehensive income must be shown in the
stockholders’ equity section separate from capital stock, additional paid in
capital, and retained earnings.
Treasury Stock: a corporation’s own stock that has been issued to
shareholders and subsequently reacquired. Is NOT considered an asset but a
contra equity account. Treasury stockholders are not entitled to any of the
rights of ownership given to common shareholders, such as the right to vote or
to receive dividends.
a. Methods of Accounting for Treasury Stock: report separately in
stockholders’ equity section as a reduction in stockholders’ equity. 2
methods of accounting for—cost and par value methods. The primary
difference between the two methods is the timing of the recognition of
“gain or loss” on treasury stock transactions. Under both methods, the
“gains and losses” are recorded as a direct adjustment to stockholders’
equity and are NOT included in determination of net income. Under both
methods, shares held as treasury stock are not considered to be
outstanding.
i. Cost Method (most common; required by IFRS): treasury shares
are recorded and carried at their reacquisition cost. A gain or loss
will be determined when treasury stock is reissued or retired. The
account additional paid-in-capital from treasury stock is credited
for gains and debited for losses when treasury is reissued. Losses
may also decrease retained earnings if additional paid-in-capital
from treasury stock account does not have a balance large enough
to absorb the loss. Net income or retained earnings will never be
increased through treasury stock transactions.
ii. Par/Stated Value Method: any g/l is recorded when stock is
repurchased. Treasury shares are recorded by reducing the amount
of par value and additional paid-in-capital received at the time of
the original sale. Treasury stock is debited for par value.
VII.
VIII.
Additional paid-in-capital is debited for the pro rated share
attributable to the reacquired shares. Retained earnings is debited
for any excess of treasury stock cost over the original issue price.
Paid-in-capital is credited for any excess of the original issue price
over the treasury stock cost. The sources of capital associated with
the original issue are maintained.
Accounting for a stock issuance (To Non-Employees): If par or stated value
exists, stock may be issued above, at, or below par or stated value. Often,
stock subscriptions are sold before the stock is actually issued.
a. Stock Issued Above Par: cash will be debited for the proceeds, common
stock will be credited for par value, and additional PIC will be credited for
the excess over par.
b. Stock Issued at Par: Cash is debited and common stock is credited for par.
c. Stock Issued Below Par: (unusual); additional PIC is debited to reflect a
discount on the stock. The discount is a contingent liability to the original
owners.
d. Stock Subscriptions: a contractual agreement to sell a specified number of
shares at an agreed-upon price on credit. Upon full payment, a stock
certificate evidencing ownership in the corporation is issued.
e. Stock Rights: provide an existing shareholder with the opportunity to buy
additional shares; no journal entry when rights are issued, only when
exercised.
Distributions to Shareholders: a dividend is a pro-rata distribution by a
corporation based on the shares of a particular class of stock and usually
represents a distribution of earnings. Cash dividends are the most common
type of dividend distribution, although there are many other types. Preferred
stock usually pays a fixed dividend, expressed in dollars or as a percentage
a. Terms
i. Date of Declaration: the date the board of directors formally
approves a dividend. A liability is created (dividends/p)
ii. Date of record: the date the board of directors specifies as the date
the names of the shareholders to receive the dividend are
determined.
iii. Date of Payment: the date on which the dividend is actually
disbursed
b. Cash Dividend: distribution of cash to shareholders and may be declared
on common or preferred stock. Paid from retained earnings. Paid only on
authorized, issued, and outstanding shares.
c. Property (in-kind) Dividends: a distribution of non-cash assets to
shareholders; nonreciprocal transfers of non-monetary assets from the
company to its shareholders. On the date of declaration, the property to be
distributed should be restated to fair value and any g/l should be
recognized in income. The dividend liability and related debit to retained
earnings (dividends) should be recorded at fair value of the assets
transferred.
IX.
d. Script Dividends: a special form of notes payable whereby a corporation
commits to paying a dividend at some later date. Often used when there is
a cash shortage. On the date of declaration, retained earnings (dividends)
is debited and n/p (not dividends/p) is credited.
e. Liquidating Dividends: occur when dividends to shareholders exceed
retained earnings. Dividends in excess of retained earnings would be
charged first to additional PIC and then to common or preferred stock.
Liquidating dividends reduce total PIC.
f. Stock Dividends: additional shares of a company’s own stock is
distributed to shareholders
i. Treatment of a small stock dividend (<20-25%): use FMV; the
issuance is treated as a small stock dividend b/c the issuance is not
expected to affect the market price of stock. The FMV of the stock
dividend at the date of declaration is transferred from retained
earnings to capital stock and additional PIC.
ii. Treatment of a Large stock dividend (>20-25%): use par; such
dividend is treated as large b/c it may be expected to reduce the
market price of stock (similar to a stock split). The par value of
stock dividend is normally transferred from retained earnings to
capital stock in order to meet legal requirements.
g. Stock Splits: a corporation issues additional shares of its own stock to
current shareholders and reduces the par value per share proportionately.
No entry (just a memo notation).
Accounting for Stock Issued to Employees: a stock option is the right to
purchase shares of a corporation’s stock under fixed conditions of time, place,
and amount. Under traditional stock option and stock purchase plans, an
employer corporation grants options to purchase shares of its stock, often at a
price lower than the prevailing market, making it possible for the individual
exercising the option to have a potential profit at the moment of acquisition.
Most option agreements provide that the purchaser must retain the stock for a
minimum period, thus reducing the possibility of speculation. The cost of
compensation is measured by the excess of the fair market value of the stock
over the option price or by the fair value based on an option pricing model.
Stock options or purchase plans can be either non-compensatory or
compensatory.
a. Non-compensatory: no entry until exercise
i. Intention: not primarily to compensate; a corporation may wish to
raise capital or diversify ownership of its stock among its
employees or officers
ii. Characteristics
1. Substantially all full-time employees meeting limited
employee qualifications may participate. Officers and
employees owning a specific amount of o/s stock are often
excluded.
2. Stock is offered to eligible employees equally, but the plan
may limit the total amount of shares that can be purchased.
3. The time to exercise the option is limited to a reasonable
period.
4. Any discount from the market price is no greater than
would be a reasonable offer of stock to shareholders or
others.
b. Compensatory: journal entry when granted;
i. Intrinsic value method: compensation cost is the excess of the FV
of the stock at the measurement date over the amount the employee
must pay.
ii. Fair Value Method: Preferable; compensation cost is based on the
FV of the equity instrument awarded, determined by an option
pricing model, net of any amount the employees must pay for the
instrument when it is granted.
c. Definitions
i. Option price: exercise price; the price at which the underlying
stock can be purchased pursuant to the option contract.
ii. Exercise date: the date by which the option holder must use the
option to purchase the underlying.
iii. Underlying: the common stock that can be purchased upon the
exercise of the option.
iv. Market value: the value at which property would change hands
between a willing seller and a willing buyer.
v. Fair value: the market value of the underlying plus the market
value of the option.
vi. Grant date: date the option is issued.
vii. Vesting Period: period over which the employee has to perform
services in order to earn the right to exercise the options;
Compensation is recognized over the service period.
viii. Black-Scholes Option Pricing Model: attempts to determine the
value of an option by measuring the difference between the PV of
the underlying on the exercise date and the PV of the option price
on the exercise date. Used to determine compensation expense.
ix. Stock Appreciation Rights (SARs): Incentive where officers are
given cash if the stock goes up after grant date.