11-1
Stockholders’ Equity:
Paid-In Capital
Chapter 11
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
1
LEARNING OBJECTIVE 11-1:
Explain the advantages and disadvantages
of organizing a business as a corporation.
11-2
2
11-2
Corporations
An entity created
by law.
Existence is
separate from
owners.
Ownership
can be
Privately, or
Closely Held
Has rights and
privileges.
Publicly Held
11-3
3
Advantages of Incorporation
Limited personal
liability for
stockholders
Transferability of
ownership
Professional
management
Continuity of
existence
11-4
4
11-3
Disadvantages of Incorporation
Heavy taxation
Greater regulation
Cost of formation
Separation of
ownership and
management
11-5
5
Formation of a Corporation
• Each corporation is
formed according to
the laws of the state
where it is located.
The costs associated with
incorporation are usually
expensed immediately, but
amortized over 5 years for
tax purposes.
• The application for
corporate status is
called the Articles of
Incorporation.
11-6
6
11-4
LEARNING OBJECTIVE 11-2:
Distinguish between publicly owned and
closely held corporations
11-7
7
Publicly Owned Corporations Face
Different Rules
By law, publicly owned corporations must:
 Prepare financial statements in accordance with
GAAP.
 Have their financial statement audited by an
independent CPA.
 Comply with federal securities laws.
 Submit financial information for SEC review.
11-8
8
11-5
LEARNING OBJECTIVE 11-3:
Explain the rights of stockholders and the
roles of corporate directors and officers
11-9
9
Rights of Stockholders
Voting (in person
or by proxy).
Rights
Stockholders
Proportionate
distribution of
dividends.
Proportionate
distribution of
assets in a
liquidation.
11-10
10
11-6
Rights of Stockholders
Corporate Organization Chart
Ultimate
control
Stockholders
usually meet
once a year.
11-11
11
Functions of the Board of Directors
Corporate Organization Chart
Primary functions
are to set
corporate policies
ad protect
stockholders.
11-12
12
11-7
Functions of the Corporate Officers
Corporate Organization Chart
Contractual and
legal representation
Chief
Accountant
Custodian
of funds
11-13
13
Stockholder Records in a
Corporation
Stockholder ledgers are often maintained by a
stock transfer agent or stock registrar.
Stockholders usually meet once a year.
Each unit of ownership is called a share of stock.
Stock certificates serve as proof that a
stockholder has purchased shares.
When the stock is sold, the stockholder signs a
transfer endorsement on the back of the stock
certificate.
11-14
14
11-8
LEARNING OBJECTIVE 11-4:
Account for paid-in capital and prepare
the equity section of a corporate balance
sheet
11-15
15
Stockholders’ Equity 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
11-16
16
11-9
Authorization and Issuance
of Capital Stock
Authorized
Shares
The maximum
number of
shares of capital
stock that can be
sold to the
public.
11-17
17
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.
11-18
18
11-10
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.
11-19
19
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.
11-20
20
11-11
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
11-21
21
Issuance of Par Value Stock
Record:
1. The cash received.
2. The number of shares issued × the par value
per share in the Common Stock account.
3. The remainder is assigned to Additional
Paid-in Capital.
Assume a corporation issues 10,000 shares
of its $2 par value stock for $8 per share.
11-22
22
11-12
Issuance of Par Value Stock
Assume a corporation issues 10,000 shares
of its $2 par value stock for $8 per share.
Description
Cash
Common Stock
Additional Paid-in Capital
Debit
Credit
80,000
20,000
60,000
10,000 × $2 = $20,000
11-23
23
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
Additional paid-in capital
Total Paid-in Capital
Retained earnings
Total stockholders' equity
$
20,000
60,000
$ 80,000
150,000
$ 230,000
11-24
24
11-13
Brief Exercise: 11.1, 11.2
11-25
25
LEARNING OBJECTIVE 11-5:
Contrast the features of common stock
with those of preferred stock.
11-26
26
11-14
Common Stock and Preferred Stock
The following stockholders’ equity section illustrates the balance
sheet presentation for a company that has both common and
preferred stock outstanding.
Stockholders' equity:
Preferred stock, 9% cumulative, $100 par value, authorized
100,000 shares, issued and outstanding 50,000 shares
Common stock, $5 par value, authorized 3,000,000 shares,
issued and outstanding 2,000,000 shares
Additional paid-in capital:
Preferred stock
Common stock
Total paid-in capital
Retained earnings
Total stockholders' equity
$
5,000,000
10,000,000
500,000
20,000,000
35,500,000
17,500,000
$ 53,000,000
11-27
27
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.
11-28
28
11-15
Cumulative Preferred 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.
11-29
29
Stock Preferred as to Dividends
Assume that a corporation is organized on January 1, 2013, with 10,000
shares of $8 preferred stock and 50,000 shares of common stock. If the
preferred stock is noncumulative, the $8 per share dividend does not
carry forward if it is not paid each year.
On the other hand, if the preferred stock is cumulative, the $8 per share
dividend carries forward to future years if it is not paid and the
accumulated amount must be paid before any dividend can be paid on
common stock. Assume that the $8 preferred dividend is paid in 2013, a
partial dividend of $2 per share is paid on preferred stock in 2014, and
no preferred dividend is paid in 2015.
11-30
30
11-16
Other Features of 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.
11-31
31
The Primary Sources of Corporate
Equity
11-32
32
11-17
Book Value per Share
of Common Stock
Preferred stock and preferred
dividends in arrears are deducted
from total stockholders’ equity.
Total Stockholders’ Equity
Number of Common Shares Outstanding
Book Value ≠ Market Value
11-33
33
Book Value With Both Preferred and
Common Stock
Hart Company has paid no dividends in the current year. As of
December 31st, dividends in arrears on cumulated preferred
stock total $80,000. All equity belongs to common stockholders
except the $1,000,000 applicable to preferred stock and the
$80,000 dividends in arrears. Here is the calculation of book
value for common stock:
Total stockholders' equity
Less: Equity of preferred stockholders"
Par value of preferred stock
Dividends in arrears
Equity of common stockholders
Number of common shares outstanding
Book value per share of common stock
$ 2,380,000
$ 1,000,000
80,000
1,080,000
1,300,000
50,000
$
26.00
11-34
34
11-18
Brief Exercise: 11.3, 11.4, 11.5,
Exercise: 11.3, 11.4,
Problem Set A: 11.4A, 11.5A
Problem Set B: 11.4B, 11.5B
11-35
35
LEARNING OBJECTIVE 11-6:
Discuss the factors affecting the market
price of preferred stock and common stock
11-36
36
11-19
Market Value
Accounting by
the issuer.
Common stock is
carried at original issue
price.
Accounting by
the investor.
Investments in
marketable securities
are carried at market
value.
11-37
37
Market Price of Preferred Stock
Factors affecting market price of preferred
stock:
• Dividend rate
• Risk
• Level of interest rates
The return based on the
market value is called the
“dividend yield.”
11-38
38
11-20
Market Price of Common Stock
Factors affecting
market price of
common stock:
 Investors’
expectations of
future profitability.
 Risk that this level
of profitability will
not be achieved.
Changes in
market value
have no impact
on the books
of the issuer.
11-39
39
Brief Exercise: 11.6, 11.7
Exercise: 11.5, 11.6, 11.7, 11.8,
Problem Set A: 11.1A, 11.2A,
11.3A, 11.6A
Problem Set B: 11.1B, 11.2B,
11.3B, 11.6B
11-40
40
11-21
LEARNING OBJECTIVE 11-8:
Explain the purpose and effects of a stock
split
11-41
41
Stock Splits
 Companies use
stock splits to
reduce market
price.
 Outstanding
shares increase,
but par value is
decreased
proportionately.
Ice Cream Parlor
Stock Splits
Now
Available
11-42
42
11-22
Stock Split
Assume that Felix Corporation has
1,000,000 shares of $10 par value
common stock outstanding with a
market price of $90 before a 2–for–1
stock split.
Common Stock Shares
Before Split
1,000,000
Par Value per Share
$
10.00
Total Par Value
$ 10,000,000
After Split
2,000,000
$
5.00
$ 10,000,000
Increase
Decrease
No
Change
11-43
43
Brief Exercise: 11.8,
Exercise: 11.10
11-44
44
11-23
LEARNING OBJECTIVE 11-9:
Account for treasury stock transactions
11-45
45
Treasury Stock
No voting
or
dividend
rights
Treasury
shares are
issued
shares that
have been
reacquired
by the
corporation.
When stock is reacquired, the corporation
records the treasury stock at cost.
11-46
46
11-24
Recording Purchases of
Treasury Stock
Riley Corporation reacquires 1,600 of its
own $5 par common shares in the open
market at $90 per share.
Prepare the journal entry to record the
purchase of treasury stock.
Description
Treasury Stock
Cash
Debit
Credit
144,000
144,000
1,600 shares × $90 = $144,000
11-47
47
Recording Reissuance of
Treasury Stock
Riley Corporation reissued 1,000 shares of
the treasury stock originally purchased for
$90 per share. The shares were reissued at
$115 per share.
1,000 shares × $115 = $115,000
Description
Cash
Treasury Stock
Additional Paid-in Capital: Treasury Stock
Debit
Credit
115,000
90,000
25,000
1,000 shares × $90 cost = $90,000
11-48
48
11-25
Stockholders’ Equity Presentation
Stockholders' Equity
Contributed capital:
Common Stock - $5 par value; 250,000 shares
authorized; 100,000 shares issued (600 held in treasury)
Additional Paid-in Capital:
Common Stock
Treasury Stock
Total Paid-in Capital
Retained earnings
Subtotal
Less: Treasury stock (600 x $90)
Total Stockholders' equity
$
500,000
$
800,000
25,000
1,325,000
650,000
1,975,000
54,000
1,921,000
$
$
$
11-49
49
Stock Buyback Programs
Some corporations have buyback programs, in which
they repurchase large amounts of their own common
stock. As a result of these programs, treasury stock
has become a material item in the balance sheet of
many corporations.
Stock option plans are an important part of employee
compensation for many companies. Treasury stock
purchases are an effective means by which the
company can have available the shares of stock
needed to satisfy the requirement of stock option plans
to issue the shares of stock to employees.
11-50
50
11-26
Financial Analysis and
Decision Making
Return on
Total Assets =
Return on Common
Stockholders’ Equity =
Net Income
Average Total Assets
Net Income
Average Common Stockholders’ Equity
11-51
51
Brief Exercise: 11.9, 11.10
Exercise: 11.2, 11.9, 11.11, 11.13, 11.14
Problem Set A: 11.8A, 11.9A
Problem Set B: 11.8B, 11.9B
11-52
52