McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 11 Reporting and Interpreting Stockholders’ Equity PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Fred Phillips, Ph.D., CA Learning Objective 1 Explain the role of stock in financing a corporation 11-3 Corporate Ownership The major advantage of the corporate form of business is the ease of raising capital as both large and small investors can participate in corporate ownership. Simple to become an owner Easy to transfer ownership Provides limited liability Because a corporation is a separate legal entity, it can Own assets. Incur liabilities. Sue and be sued. Enter into contracts. 11-4 Corporate Ownership Voting rights. Dividends. Stockholder Benefits Residual claims. Preemptive rights. 11-5 Corporate Ownership Stockholders (Owners of voting shares) Board of Directors Appointed by directors Vice President (Production) 11-6 Elected by shareholders President Vice President (Marketing) Vice President (Finance) Vice President (Personnel) Equity Versus Debt Financing Advantages of equity and debt financing. 11-7 Advantages of equity Advantages of debt • Equity does not have to be repaid. • Interest on debt is tax deductible. • Dividends are optional. • Debt does not change stockholder control. Learning Objective 2 Explain and analyze common stock transactions. 11-8 Common Stock Transactions Two primary sources of Stockholders’ Equity Contributed Capital Common Stock 11-9 Additional Paid-in Capital Retained Earnings Authorization, Issuance, and Repurchase of Stock Authorized Shares Issued Shares 11-10 Outstanding shares are issued shares that are owned by stockholders. Issued Unissued shares are shares of Outstanding The maximum number Unissued authorized stock are Shares of shares of capital Shares shares of shares that be never stockstock that that can have Treasury shares are haveissued been to the public. been Treasury issued shares distributed to distributed to that have Shares been reacquired by the stockholders. stockholders. corporation. Authorization, Issuance, and Repurchase of Stock 11-11 Stock Authorization Par value is typically a very nominal amount such a $0.01 per share. Par value is an arbitrary amount assigned to each share of stock when it is authorized. 11-12 Market price is the amount that each share of stock will sell for in the market. Stock Authorization No-par Stock Some states do not require a par value to be stated in the charter. 11-13 Stock Issuance Initial public offering (IPO) Seasoned new issue The first time a corporation issues stock to the public. Subsequent issues of new stock to the public. National Beverage issues stock. 11-14 Stock Issuance Most issues of stock to the public are cash transactions. National Beverage issued 100,000 shares of $0.01 par value common stock for $10 per share. 1 2 11-15 Analyze Record Stock Exchanged between Investors Transactions between two investors do not affect the corporation’s accounting records. I’d like to sell 100 shares of National Beverage stock. 11-16 I’d like to buy 100 shares of National Beverage stock. Repurchase of Stock A corporation repurchases its stock to: Send a signal that the company believes its stock is undervalued. Obtain shares to reissue for the purchase of other companies. Obtain shares to reissue to employees as part of stock purchase or stock option plans. Treasury Stock 11-17 Repurchase of Stock National Beverage repurchases its own stock (Treasury stock) Stockholders Employee compensation package includes salary plus stock options. Stock options allow employees to purchase stock from the corporation at a fraction of the stock’s market price. Employee 11-18 Repurchase of Stock No voting or dividend rights Contra equity account Treasury stock is not an asset. When stock is reacquired, the corporation records the treasury stock at cost. 11-19 Repurchase of Stock National Beverage reacquired 50,000 shares of its common stock at $25 per share. 1 2 11-20 Analyze Record Reissuance of Treasury Stock National Beverage reissued 5,000 shares of the Treasury Stock at $26 per share. 1 2 Analyze Record No profit or loss is recognized on treasury stock transactions. 11-21 Learning Objective 3 Explain and analyze cash dividends, stock dividends, and stock split transactions. 11-22 Dividends on Common Stock Declared by board of directors. Not legally required. Creates liability at declaration. Requires sufficient Retained Earnings and Cash. 11-23 Restrictions on Retained Earnings If I loan your company $1,000,000, I will want you to restrict your retained earnings to limit dividend payments. Loan agreements can include restrictions on paying dividends below a certain amount of retained earnings. 11-24 Dividends Dates 11-25 Dividends Dates National Beverage declares an $0.80 dividend on each share of its 46,000,000 shares of common stock outstanding. 1 2 11-26 Analyze Record Dividends Dates National Beverage paid the previously declared $0.80 dividend on its shares of common stock outstanding. 1 2 11-27 Analyze Record Stock Dividends Distribution of additional shares of stock to stockholders. No change in total stockholders’ equity. No change in par values. All stockholders retain same percentage ownership. Corporations issue stock dividends to: Remind stockholders of the accumulating wealth in the company. Reduce the market price per share of stock. Signal that the company expects strong financial performance in the future. 11-28 Stock Dividends Small Large Stock dividend < 20 – 25% Stock dividend > 20 – 25% Record at current market value of stock. Record at par value of stock. The journal entry moves an amount from Retained Earnings to other equity accounts. 11-29 Stock Dividends National Beverage issued a 20 percent stock dividend on 38,000,000 outstanding shares of its $0.01 par value common stock and accounted for it as a large stock dividend. 1 2 11-30 Analyze Record Stock Splits An increase in the number of shares and a corresponding decrease in par value per share. Retained earnings is not affected. A stock split creates more pieces of the same pie. Assume that a corporation had 5,000 shares of $1 par value common stock outstanding before a 2–for–1 stock split. 11-31 Common Stock Shares Before Split 5,000 After Split 10,000 Increase Par Value per Share $ 1.00 $ 0.50 Decrease Total Par Value $ 5,000 $ 5,000 No Change Comparison of Distributions to Stockholders Stockholders' Equity Contributed Capital Number of common shares outstanding Par value per common share Common stock, at par Additional paid-in capital Retained Earnings Total stockholders' equity 11-32 Before 1,000,000 $ 0.01 $ 10,000 30,000 650,000 $ 690,000 After 2-for-1 Stock 100% Stock Split Dividend $10,000 Cash Dividend 2,000,000 $ 0.005 $ 10,000 30,000 650,000 $ 690,000 1,000,000 $ 0.01 $ 10,000 30,000 640,000 $ 680,000 2,000,000 $ 0.01 $ 20,000 30,000 640,000 $ 690,000 Learning Objective 4 Describe the characteristics of preferred stock and analyze transactions affecting preferred stock. 11-33 Preferred Stock Issuance Priority over common stock Preferred Stock Usually has a fixed dividend rate Usually has no voting rights National Beverage issued 10,000 shares of its $1 par value preferred stock for $5 per share. 1 2 11-34 Analyze Record Preferred Stock Dividends • Current Dividend Preference: The current preferred dividends must be paid before paying any dividends to common stock. • Cumulative Dividend Preference: Any unpaid dividends from previous years (dividends in arrears) must be paid before common dividends are paid. If the preferred stock is noncumulative, any dividends not declared in previous years are lost permanently. 11-35 Preferred Stock Dividends In addition to its common stock, National Beverage has $1 par value cumulative preferred stock with a 7 percent dividend rate. Assume 100,000 of these shares are outstanding, one year of dividends are in arrears, and the board of directors just declared total dividends of $400,000. How much will each class of stock receive? 11-36 Preferred Stock Dividends Total dividend declared Preferred stock (cumulative) In Arrears ($1 par × 7% × 100,000 shares) Current Yr. ($1 par × 7% × 100,000 shares) Remainder $ $ 7,000 7,000 14,000 $ Common stock Remainder 11-37 400,000 386,000 386,000 $ - Retained Earnings Total cumulative amount of reported net income less any net losses and dividends declared since the company started operating. Baker Company Comparative Balance Sheets (Partial) For Year Ended December 31 2009 2008 Stockholders' Equity Common Stock Additional Paid-in Capital Retained Earnings (Deficit) Total Stockholders' Equity $ 100,000 750,000 50,000 900,000 $ 100,000 750,000 (70,000) 780,000 Baker Company incurred a loss of $120,000 in 2009 that resulted in an Accumulated Deficit in Retained Earnings. 11-38 Learning Objective 5 Analyze the earnings per share (EPS), return on equity (ROE), and price/earnings (P/E) ratios. 11-39 Earnings Per Share (EPS) Earnings per share is probably the single most widely watched financial ratio. Net Income EPS = Average Number of Common Shares Outstanding National Beverage’s income for 2008 was $22,500,000 and the average number of shares outstanding during the year was 45,900,000. EPS = 11-40 $22,500,000 45,900,000 Shares = $0.49 per share Return on Equity (ROE) Return on equity is the amount earned for each dollar invested by stockholders. ROE = Net Income Average Stockholders’ Equity National Beverage’s income for 2008 was $22,500,000 and the average Stockholders’ Equity was $151,000,000. ROE 11-41 = $22,500,000 $151,000,000 = 14.9 percent Price/Earnings (P/E) Ratio The P/E ratio is a measure of the value that investors place on a company’s common stock. P/E = Current Stock Price (per share) Earnings Per Share (annual) National Beverage’s stock price was $7.74 when the company reported its 2008 EPS of $0.49. P/E 11-42 = $ 7.74 $ 0.49 = 15.8 Comparison of EPS, ROE, and P/E Ratios 11-43 National Beverage EPS $ 0.49 2008 ROE 14.9% P/E 15.8 Pepsico $ 3.26 34.8% 16.0 Supplement 11A Owners’ Equity for Other Forms of Business Owner’s Equity for a Sole Proprietorship Only two owner’s equity accounts. 11-45 A capital account to record the owner’s investments and the periodic income or loss. A withdrawal account to record the owner’s withdrawals of assets. No separate retained earnings account. Closed to the capital account at the end of each period. Accounting for Owner’s Equity for a Sole Proprietorship To record a $150,000 investment by H. Simpson, the owner. To record H. Simpson’s $1,000 monthly withdrawal. 11-46 Accounting for Owner’s Equity for a Sole Proprietorship To close revenue and expense accounts to capital. To close the $1,000 monthly drawings to capital. 11-47 Accounting for Partnership Equity Accounting for assets, liabilities, revenues and expenses follows the same accounting principles as any other form of business. Accounting for partners’ equity follows the same pattern as for a sole proprietorship. Separate capital and drawings accounts are maintained for each partner. 11-48 Accounting for Partnership Equity To record investments by partners Able and Baker who will divide net income as follows: Able, 60 percent and Baker 40 percent. To record the partners’ monthly withdrawal. 11-49 Accounting for Partnership Equity To close revenue and expense accounts to partners’ capital. To close the monthly drawings to partners’ capital. 11-50 Other Business Forms Limited Liability Partnership (LLP) 11-51 Limited Liability Company (LLC) • Protects innocent partners from malpractice or negligence claims. • Owners have same limited liability feature as owners of a corporation. • Most states hold all partners personally liable for partnership debts. • A limited liability corporation typically has a limited life. Chapter 11 Solved Exercises M11-4, M11-8, E11-3, E11-6, E11-8, E11-11, E11-20 M11-4 Analyzing and Recording the Issuance of Common Stock To expand operations, Aragon Consulting issued 100,000 shares of previously unissued common stock with a par value of $1. The price for the stock was $75 per share. Analyze the accounting equation effects and record the journal entry for the stock issuance. 1 Analyze Cash 2 Assets + 7,500,000 = Liabilities Stockholders' Equity Common Stock + 100,000 Additional Paid-in Capital + 7,400,000 Record dr Cash (+A) cr Common Stock (+SE) cr Additional Paid-in Capital (+SE) 11-53 + 7,500,000 100,000 7,400,000 M11-4 Analyzing and Recording the Issuance of Common Stock Would your answer be different if the par value were $2 per share? If, so, analyze the accounting equation effects and record the journal entry for the stock issuance with a par value of $2. The effects on total assets and total stockholders’ equity would not differ, but the amounts within the individual stockholders’ equity accounts would differ. 1 Analyze Cash 2 Assets + 7,500,000 = Liabilities Stockholders' Equity Common Stock + 200,000 Additional Paid-in Capital + 7,300,000 Record dr Cash (+A) cr Common Stock (+SE) cr Additional Paid-in Capital (+SE) 11-54 + 7,500,000 200,000 7,300,000 M11-8 Determining the Amount of a Dividend Netpass Company has 300,000 shares of common stock authorized, 270,000 shares issued, and 100,000 shares of treasury stock. The company’s board of directors declares a dividend of 50 cents per share of common stock. What is the total amount of the dividend that will be paid? Dividends are paid on shares that are issued and outstanding. Dividends are not paid on treasury stock. Shares issued Less treasury stock Shares outstanding Dividend per share Total dividends paid 11-55 270,000 100,000 170,000 × $ 0.50 $ 85,000 E11-3 Preparing the Stockholders’ Equity Section of the Balance Sheet North Wind Aviation received its charter during January 2010. The charter authorized the following capital stock: During 2010, the following transactions occurred in the order given: a. Issued a total of 40,000 shares of the common stock to the company’s founders for $11 per share. b. Issued 5,000 shares of the preferred stock at $18 per share. c. Issued 3,000 shares of the common stock at $14 per share and 1,000 shares of the preferred stock at $28. d. Net income for the first year was $48,000. Required: Prepare the stockholders’ equity section of the balance sheet at December 31, 2010. 11-56 E11-3 Preparing the Stockholders’ Equity Section of the Balance Sheet North Wind Aviation Stockholders' Equity December 31, 2010 Contributed Capital: Preferred Stock, 8%, $10 par, 20,000 shares authorized, $ 60,000 6,000 shares issued and outstanding 58,000 Additional Paid-in Capital, Preferred Common Stock, $7 par, 50,000 shares authorized, 301,000 43,000 shares issued and outstanding 181,000 Additional Paid-in Capital, Common 5,000 shares × ($18 – $10) + 1,000 shares × ($28 – $10) 600,000 Total Contributed Capital Earnings Retained 40,000 shares × ($11 – $7) + 3,000 shares × ($14 – $7) 48,000 648,000 Total Stockholders' Equity 11-57 E11-6 Recording and Reporting Stockholders’ Equity Transactions AvA School of Learning obtained a charter at the start of 2010 that authorized 50,000 shares of no-par common stock and 20,000 shares of preferred stock, par value $10. During 2010, the following selected transactions occurred: a. Collected $40 cash per share from four individuals and issued 5,000 shares of common stock to each. b. Issued 6,000 shares of common stock to an outside investor at $40 cash per share. c. Issued 8,000 shares of preferred stock at $20 cash per share. Required: 1. Give the journal entries indicated for each of these transactions. 2. Prepare the stockholders’ equity section of the balance sheet at December 31, 2010. At the end of 2010, the accounts reflected net income of $36,000. No dividends were declared. 11-58 E11-6 Recording and Reporting Stockholders’ Equity Transactions Required: 1. Give the journal entries indicated for each of these transactions. (a) Collected $40 cash per share from four individuals and issued 5,000 shares of common stock to each. dr Cash (+A) (5,000 × $40 × 4) cr Common Stock (+SE) 800,000 800,000 (b) Issued 6,000 shares of common stock to an outside investor at $40 cash per share. dr Cash (+A) (6,000 × $40) cr Common Stock (+SE) 11-59 240,000 240,000 E11-6 Recording and Reporting Stockholders’ Equity Transactions Required: 1. Give the journal entries indicated for each of these transactions. (c) Issued 8,000 shares of preferred stock at $20 cash per share. dr Cash (+A) (8,000 × $20) 160,000 cr Preferred Stock (+SE) cr Additional Paid-in Capital, Preferred (+SE) 11-60 80,000 80,000 E11-6 Recording and Reporting Stockholders’ Equity Transactions Required: 2. Prepare the stockholders’ equity section of the balance sheet at December 31, 2010. At the end of 2010, the accounts reflected net income of $36,000. No dividends were declared. AvA School of Learning Stockholders' Equity December 31, 2010 Contributed Capital: Preferred Stock, $10 par, 20,000 shares authorized, 8,000 shares issued and outstanding Additional Paid-in Capital, Preferred Common Stock, no par, 50,000 shares authorized, 26,000 shares issued and outstanding Total Contributed Capital 8,000 shares × ($20 – $10) Retained Earnings (20,000 shares × Equity $40) + (6,000 shares × ($40) Total Stockholders' 11-61 $ 80,000 80,000 1,040,000 1,200,000 36,000 1,236,000 E11-8 Recording Treasury Stock Transactions and Analyzing Their Impact During 2010, the following selected transactions affecting stockholders’ equity occurred for Corner Corporation: Feb. 1 Purchased 400 shares of the company’s own common stock at $22 cash per share. Jul. 15 Issued 100 of the shares purchased on February 1, 2010, for $24 cash per share. Sept. 1 Issued 60 more of the shares purchased on February 1, 2010, for $20 cash per share. Required: 1. Show the effects of each transaction on the accounting equation. 2. Give the indicated journal entries for each of the transactions. 3. What impact does the purchase of treasury stock have on dividends paid? 4. What impact does the issuance of treasury stock for an amount higher than the purchase price have on net income? 11-62 E11-8 Recording Treasury Stock Transactions and Analyzing Their Impact Required: 1. Show the effects of each transaction on the accounting equation. 1 Analyze Date Feb. 1 Cash Assets - 8,800 Jul, 15 Cash + 2,400 Sept. 1 11-63 Cash + 1,200 = Liabilities + Stockholders' Equity Treasury Stock (+xSE) - 8,800 Treasury Stock (-xSE) Additional Paid-in Capital – treasury treasury + 2,200 Treasury Stock (-xSE) Additional Paid-in Capital – treasury + 1,320 + 200 - 120 E11-8 Recording Treasury Stock Transactions and Analyzing Their Impact Required: 2. Give the indicated journal entries for each of the transactions. 2 Record Feb. 1 dr Treasury Stock (+xSE) (-SE) cr Cash (-A) (400 × $22) 2 2,400 2,200 200 Record Sept. 1 dr Cash (+A) (60 × $20) dr Additional Paid-in Capital – Treaasury (-SE) cr Treasury Stock (-xSE) (+SE) (60 × $22) 11-64 8,800 Record July 15 dr Cash (+A) (100 × $24) cr Treasury Stock (-xSE) (+SE) (100 × $22) cr Additional Paid-in Capital – Treaasury (+SE) 2 8,800 1,200 120 1,320 E11-8 Recording Treasury Stock Transactions and Analyzing Their Impact Required: 3. What impact does the purchase of treasury stock have on dividends paid? Dividends are not paid on treasury stock. Therefore, the total amount of cash dividends paid is reduced when treasury stock is purchased. 4. What impact does the issuance of treasury stock for an amount higher than the purchase price have on net income? The sale of treasury stock for more or less than its original purchase price does not have an impact on net income. The transaction affects only balance sheet accounts. 11-65 E11-11 Recording the Payment of Dividends and Preparing a Statement of Retained Earnings The 2009 annual report for Sneer Corporation disclosed that the company declared and paid preferred dividends in the amount of $119.9 million in 2009. It also declared and paid dividends on common stock in the amount of $2 per share. During 2009, Sneer had 1,000,000,000 shares of common authorized; 387,570,300 shares had been issued; 41,670,300 shares were in treasury stock. The balance in Retained Earnings was $1,554 million on December 31, 2008, and 2009 Net Income was $858 million. Required: 1. Prepare journal entries to record the declaration, and payment, of dividends on (a) preferred and (b) common stock. 2. Using the information given above, prepare a statement of retained earnings for the year ended December 31, 2009. 11-66 E11-11 Recording the Payment of Dividends and Preparing a Statement of Retained Earnings 1. Prepare journal entries to record the declaration, and payment, of dividends on (a) preferred and (b) common stock. a. Preferred Stock Declaration dr Dividends Declared (-SE) cr Dividends Payable (+L) 119,900,000 119,900,000 Payment dr Dividends Payable (-L) cr Cash (-A) 11-67 119,900,000 119,900,000 E11-11 Recording the Payment of Dividends and Preparing a Statement of Retained Earnings 1. Prepare journal entries to record the declaration, and payment, of dividends on (a) preferred and (b) common stock. b. Common Stock Dividends are paid on shares that are issued and outstanding. Dividends are not paid on treasury stock. Shares issued Less Treasury Stock Shares outstanding Dividend per share Total dividends paid 11-68 387,570,300 41,670,300 345,900,000 × $ 2.00 $ 691,800,000 E11-11 Recording the Payment of Dividends and Preparing a Statement of Retained Earnings 1. Prepare journal entries to record the declaration, and payment, of dividends on (a) preferred and (b) common stock. b. Common Stock Declaration dr Dividends Declared (-SE) cr Dividends Payable (+L) 691,800,000 691,800,000 Payment dr Dividends Payable (-L) cr Cash (-A) 11-69 691,800,000 691,800,000 E11-11 Recording the Payment of Dividends and Preparing a Statement of Retained Earnings 2. Using the information given above, prepare a statement of retained earnings for the year ended December 31, 2009. Sneer Corporation Statement of Retained Earnings For Year Ended December 31, 2009 Retained Earnings, January 1, 2009 Plus: Net Income Less: Dividends declared on Preferred Stock Dividends declared on Common Stock Retained Earnings, December 31 11-70 $ 1,554,000,000 858,000,000 (119,900,000) (691,800,000) $ 1,600,300,000 E11-20 Determining the Effect of a Stock Repurchase on EPS and ROE Swimtech Pools Inc. (SPI) reported the following in its financial statements for the quarter ended March 31, 2010. During the quarter ended March 31, 2010, SPI reported Net Income of $5,000 and declared and paid cash dividends totaling $5,000. Required: 1. Calculate earnings per share (EPS) and return on equity (ROE) for the quarter ended March 31, 2010. Net Income EPS = Average Number of Common Shares Outstanding EPS = 11-71 $5,000 50,000 Shares = $0.10 per share E11-20 Determining the Effect of a Stock Repurchase on EPS and ROE Required: 1. Calculate earnings per share (EPS) and return on equity (ROE) for the quarter ended March 31, 2010. ROE ROE 11-72 = Net Income Average Stockholders’ Equity = $5,000 $100,000 = 5.0 percent E11-20 Determining the Effect of a Stock Repurchase on EPS and ROE Required: 2. Assume SPI repurchases 10,000 of its common stock at a price of $2 per share on April 1, 2010. Also assume that during the quarter ended June 30, 2010, SPI reported Net Income of $5,000, and declared and paid cash dividends totaling $5,000. Calculate earnings per share (EPS) and return on equity (ROE) for the quarter ended June 30, 2010. EPS = $5,000 40,000 Shares = $0.125 per share If 10,000 shares are repurchased on April 1, 2010, only 40,000 shares would be outstanding from April 1 – June 30, 2010. 11-73 E11-20 Determining the Effect of a Stock Repurchase on EPS and ROE Required: 2. Assume SPI repurchases 10,000 of its common stock at a price of $2 per share on April 1, 2010. Also assume that during the quarter ended June 30, 2010, SPI reported Net Income of $5,000, and declared and paid cash dividends totaling $5,000. Calculate earnings per share (EPS) and return on equity (ROE) for the quarter ended June 30, 2010. ROE = $5,000 $80,000 = 6.25 percent 10,000 shares are repurchased for $20,000 on April 1, 2010, resulting in a Stockholders’ Equity balance of $80,000 from April 1 – June 30, 2010. 11-74 E11-20 Determining the Effect of a Stock Repurchase on EPS and ROE Swimtech Pools Inc. (SPI) reported the following in its financial statements for the quarter ended March 31, 2010. Required: 3. Based on your calculations in requirements 1 and 2, what can you conclude about the impact of a stock repurchase on EPS and ROE? By repurchasing stock, a company can increase both its EPS and ROE. 11-75 End of Chapter 11