Module 9: Stockholders’ Equity
1.Accounting for preferred and common
2.Treasury stock
3.Stock compensation plans
4.Retained earnings
-cash dividends
-stock dividends (and stock splits)
-property dividends (and other carve outs)
5.Other comprehensive income
6.Statement of stockholders’ equity
7.Convertible securities
8.Comprehensive example
1
1. Preferred Stock

Advantages
–
–
–
–

Preference over common in liquidation
Stated dividend
Variety of features regarding dividends
Preference over common in dividend payout
Disadvantages
– Subordinate to debt in liquidation
– Stated dividend can be skipped
– No voting rights (versus common)

Debt or equity?
– components of both
– usually (but not always) classified with equity
2
1. Common Stock

Advantages
– Voting rights:
 election of board of directors
 vote on significant activities of management
– Rights to residual profits (after preferred)

Disadvantages
– Last in liquidation
– No guaranteed return
3
1. Accounting for Common Stock
(CS) and Preferred Stock (PS)

Par value - initially established to create a
“minimum legal capital”.
– Ex: Minimum legal capital in some states is
$1,000 for new corporations, so issue:



1,000 shares at $1par, or
100 shares at $10 par, or other combination. . .
Par value is not market value.
 Credit CS or PS for par value.
 Excess over par credited to “Paid in Capital in
Excess of Par or Stated Value” or abbreviated:
“Additional Paid-in Capital” (APIC).
 Some newer stock issues (for common stock) are
“no par” stock.
4
1. Journal Entries
Issue PS at greater than par value:
Cash
xx
mkt. value
Preferred Stock
xx total par
APIC - PS
xx excess(plug)
Issue CS at greater than par value:
Cash
xx
mkt. value
Common Stock
xx total par
APIC - CS
xx excess(plug)
Note: most states do not allow companies
to issue at less than par value.
5
1. Journal Entries -continued
Issue no par common stock:
Cash
xx
Common Stock
xx
mkt. value
mkt. value
Note: many companies have newer stock
issues that are no par, but most companies
still have older stock issues which contain a
par value and APIC.
The Stockholders’ Equity section of the balance
sheet of Sample Company illustrates many of
the components of SE discussed in this
chapter.
6
Sample Co. Stockholders’ Equity
Common stock, $1 par value, 500,000 shares
authorized, 80,000 shares issued, and
75,000 shares outstanding
$ 80,000
Common stock dividends distributable
2,000
Preferred stock, $100 par value, 1,000 shares
authorized, 100 shares issued and
outstanding
10,000
Paid in capital on common
$ 20,000
Paid in capital on preferred
3,000
Paid in capital on treasury stock
2,000
25,000
Retained earnings:
Unappropriated
$18,000
Appropriated
4,000
22,000
Less: Treasury stock, 5,000 shares (at cost)
(6,000)
Less: Other comprehensive income
(2,000)
Total Stockholders’ Equity
$131,000
7
Journal Entries-Sample Co.
Now, using Sample Company information,
record the following additional issues of
common and preferred stock:
Issued 100 shares of PS at $102 per share:
Cash (100x $102) 10,200
PS (100x $100 par)
10,000
APIC - PS (plug)
200
Issued 500 shares of CS at $5 per share:
Cash (500 x $5)
2,500
CS (500 x $1 par)
500
APIC - CS (plug)
2,000
8
2. Treasury Stock

Created when a company buys back shares of
its own common stock.
 Reasons for buyback:
– reissue to employees for compensation.
– hold in treasury (or retire) to increase market
price and earnings per share.
– reduce total dividend payouts while
maintaining per share payouts.
– thwart takeover attempts by reducing
proportion of shares available for purchase.
– give cash back to existing shareholders.
9
2. Treasury Stock - continued
The debit balance account called “Treasury
Stock” is reported in stockholders’ equity as a
contra (reduces SE). Note: not an asset.
 The stock remains issued, but is no longer
outstanding.

– does not have voting rights
– cannot receive cash dividends

May be reissued (to the market or to employees)
or retired.
 No gains or losses are ever recognized from
these equity transactions.
10
2. Treasury Stock(TS) - Journal Entries
There are two techniques for recording TS
transactions (Par Value method and Cost
method). We will use only the Cost method.
This technique establishes a “cost” for TS
equal to the amount paid to acquire the TS.
Par value is not used for TS transactions.
To record purchase of TS from market:
TS
xx
“cost”
Cash
xx market
(cost equals the cash paid)
11
2. Treasury Stock(TS) - Journal Entries
To reissue TS to market at greater than cost:
Cash
xx
market
APIC - TS
xx over cost
TS
xx cost
To reissue TS to market at less than cost:
Cash
xx
market
APIC - TS
xx
if available
Retained Earnings xx
if needed*
TS
xx cost
*debit RE if no APIC-TS available to absorb the
remaining debit difference.
12
2. TS - Example Problem
Tech Corporation has 100,000 shares of $1 par
value stock authorized, issued and outstanding
at January 1, 2013. The stock had been issued
at an average market price of $5 per share, and
there have been no treasury stock transactions
to this point.
Assume that, in February of 2013, Tech Corp.
repurchases 10,000 shares of its own stock at
$7 per share. In July of 2013, Tech Corp.
reissues 2,000 shares of the treasury stock for
$8 per share. In December of 2013, Tech Corp.
reissues the remaining 8,000 shares for $6 per
share. Prepare the journal entries for 2013
regarding the treasury stock.
13
2. TS Example -Journal Entries
Feb: repurchase 10,000 sh. @ $7 =
$70,000.
July: reissue 2,000 sh @ $ 8 = $16,000
(cost = 2,000 @ $7 = 14,000)
14
2. TS Example -Journal Entries
Dec: reissue 8,000 sh. @ $ 6 = $48,000
(cost = 8,000 sh.@ $7 = 56,000)
Now we need to debit one or more accounts to
compensate for the difference.
(1) debit APIC-TS (but lower limit is to -0-).
(2) debit RE if necessary for any remaining
balance (this is only necessary when we
are decreasing equity).
15
3. Employee Stock Compensation Plans

Historically, companies granted stock options to
employees as a means of compensating
employees, without having to recognize any
compensation expense.
 Recently, the FASB required compensation
expense to be recognized on the income
statement, based on estimated fair value of the
option.
 Many companies have been shifting to restricted
stock plans to compensate and motivate
employees.
 The restricted stock plans require a recognition of
compensation expense, but based on the value
of the stock at the date of grant (rather than fair
value at date of full vesting).
16
3. Employee Stock Options-History

Since 1970, APB Opinion 25 allowed the issue of
employee stock options. When the options were
granted at the market price at grant date, no
compensation expense was necessary.
 SFAS No. 123 was issued in 1995, and introduced
the fair value method for calculating the
compensation expense relating to employee stock
options.
 SFAS No. 123 recommended that expense be
recognized in the income statement, but did not
require this recognition.
 SFAS No. 123R was issued in 2004, to require the
recognition of expense in the income statement,
for public companies whose fiscal year begins
after June 15, 2005.
17
3. Stock Options-Illustration 1
Given the following information: Em
Company adopted a stock option plan that
granted options to employees to purchase
30,000 shares of the company’s $10 par
value common stock. The options were
granted on January 2, 2011, and were
exercisable 2 years after the date of grant if
the employee was still employed at the
company. The exercise price was set at
$40 in the option contract. At the date of
exercise January 2, 2013, the market price
was $80 per share.
18
3. Stock Options - Illustration 1
Illustration (SFAS 123R, fair value method):
Assume the market price at the date of grant
was $40 per share, and the stock options are,
therefore, noncompensatory. However,
compensation expense is estimated using the
Black-Scholes option pricing model (other
models are acceptable), and the present
value of the estimated total compensation
expense (based on the projected market
price at exercise) is $200,000.
19
3. Stock Options - Illustration 1
Basically, the pricing model assumes a number
of factors which could affect the growth in the
price of the stock, and also incorporates
probabilities for the number of employees that
would actually exercise the option.
Since total compensation expense = $200,000,
we will recognize it over the life of the option
(200,000/2 = $100,000 per year).
The journal entries in Illustration 1 are required
with SFAS No. 123R.
20
3. Stock Options - Illustration 1
(SFAS 123R: required journal entries)
For 2011:
Compensation expense
100,000
APIC - stock options
100,000
For 2012:
Compensation expense
100,000
APIC - stock options
100,000
Jan. 2, 2013:
Cash ($40 x 30,000)
1,200,000
APIC - stock options
200,000
Common stock ($10 x 30,000)
300,000
APIC - common stock (plug) 1,100,000
Note that, even though the market price of the stock at 1/2/13 is $80 per
share, the transaction is recorded at the PV of the estimated future price at
the date of exercise ($46.67 per share). The company never recognizes
the additional “value” that it has given to the employees.
21
3.Restricted Stock-Illustration 2
Given the following information: Que Company
adopted a stock compensation plan that issued
10,000 shares of restricted stock to employees at
January 2, 2011. The par value of the common stock
was $10, and the stock was trading at $15 per share
at the issue date. The vesting period was 2 years;
after that time the stock would be unrestricted. The
journal entry at the time of issue (1/2/11) would be
(10,000 sh. x $15 = $150,000):
Deferred comp. expense
150,000
CS (Restricted)
100,000
APIC - CS
50,000
(Note: Deferred Comp. is part of Other Comprehensive
Income, until it is transferred to Income Statement over the 2
year vesting period.)
22
3. Restricted Stock- Illustration 2
For 2011:
Compensation expense
75,000
Deferred comp. expense
For 2012:
Compensation expense
75,000
Deferred comp. expense
75,000
75,000
Jan. 2, 2013 (If separate account is used for
restricted stock - transfer par value):
CS (Restricted)
100,000
CS
100,000
(Otherwise, no journal entry required; the restriction
is released and the shares are no longer restricted.)
23
3. Equity Compensation and Expense Recognition


Should compensation expense from stock options
and restricted stock plans be recognized in the
income statement?
Proponents say yes:
– It is a cost to the company of employing the workers.
– If the company had issued stock, then paid the
employees in cash, the amount would have been
recognized as comp. expense.

Opponents say no:
– The employee is essentially working as an “owner” of
the company, and contributing “sweat equity”; owners
do not receive salary distributions.
– Options and restricted stock are given as work
incentives, rather than straight compensation.
Remember: the value can go down as well as up
(unlike traditional compensation).
– These equity grants do not meet the definition of an
expense. See page 2-11 (last paragraph).
24
4. Retained Earnings
We will be expanding the basic retained earnings
formula in this chapter. Now, the Retained Earnings
Column of the Statement of Stockholders’ Equity will
include the following:
RE, beginning
xx
Add: net income
xx
Less dividends:
Cash dividends-common
xx
Cash dividends - preferred
xx
Stock dividends
xx
Property dividends
xx
Less: Adjustment for TS transactions xx
Appropriation of RE
xx
RE, ending
xx
25
4. RE - Cash Dividends
As cash dividends are declared:
Dividends (RE) - common xx
Dividends (RE)- preferred xx
Dividends Payable
xx
As cash dividends are paid:
Dividends Payable
Cash
xx
xx
26
4. RE - Cash Dividends
 Note
that stated dividends to preferred
shareholders must be paid before any dividends
can be paid to common shareholders (including
dividends in arrears if cumulative).
 Preferred dividends may be cumulative, which
means that, if no dividend is declared in the current
year, they must be “caught up” (based on stated
dividend rate) for the preferred shareholders in a
future year before common shareholders get any
dividends.
 However, cumulative preferred dividends in arrears
are not recognized as a liability until a dividend is
finally declared by the board of directors. A
company might go for a number of years without
declaring a dividend, and there is no liability until a
dividend is actually declared.
27
4. RE - Property Dividends
Property dividends are distribution of non-cash
property by a company to its shareholders.
The most common type of property dividend is
a “spin-off” where the shares of stock of a
subsidiary are distributed to the shareholders of
the parent company. This is also called a form
of “carve out”, as the company carves out a
segment and divests it.
As property dividends are declared:
Property Dividends (RE)
xx
Property Div. Payable
xx
As property dividends are distributed:
Property Div. Payable
xx
Investment
xx
28
4. Other Carve Outs
Other forms of carve outs (though not
considered dividends) are sell-offs and splitoffs.
In a sell-off, the company sells its equity
interest in the investment/subsidiary to an
outside party.
In a split-off, the company sells its equity
interest in the subsidiary back to the subsidiary.
Thus the subsidiary is buying back its own
shares (for treasury or retirement) and the
parent is no longer an owner.
29
4. RE - Stock Dividends
Stock dividends are distribution of additional
shares of a company’s own stock to its
shareholders. Note that the distribution of
additional shares does not result in any
value being given to the shareholders.
Example: 4 shareholders, each having 10
shares of common stock. Each owner has
25% of total (10/40). If I give each
shareholder 1 additional share of stock,
each shareholder still owns 25% of the
same company (11/44). Nothing has
changed, except the number of the pieces
of paper.
30
4. RE - Stock Dividends
Large stock dividends (> 25% of the
outstanding common shares) are recorded at
par value.
As stock dividends are declared:
Stock Dividends (RE)
xx
par
Stock Div. Distributable xx par
As stock dividends are distributed:
Stock Div. Distributable xx
par
Common Stock
xx par
Note that Stock Dividends Distributable is not a liability, it
is another equity account (see Sample Company) which
indicates that there are additional shares of stock that will
be issued but are not currently outstanding.
31
4. RE - Stock Dividends
Analyze the effect of the transactions on the
balance sheet:
Stock Dividends (RE)
xx
-SE
Stock Div. Distributable
xx
+SE
As stock dividends are distributed:
Stock Div. Distributable
xx
-SE
Common Stock
xx +SE
Note that the total effect on stockholders’ equity is zero.
However, retained earnings decreases and common
stock increases by the par value of the stock dividend.
Small stock dividends (< 25% of the outstanding common
shares) are recorded at market value. Since small stock
dividends are rare, we will not do journal entries here.
32
Stock Splits
Stock splits are commonly declared by a
company to reduce its market price per
share. This makes the stock more
accessible to small investors.
 The process for stock splits is that the “old”
stock is voided, and new shares are
granted with a “new” description.
 The total par value of the new shares is
equal to the total par value of the old
shares, but the number of shares (and par
value per share changes.

33
Example of Stock Split
IZM Company has 100,000 shares of $2
par value stock authorized, 10,000 shares
issued and outstanding.
The SE section of the balance sheet
shows:
– Common stock
$20,000
– Retained earnings 80,000
The market price of the outstanding shares
is $50 per share before the split is
distributed.
34
Example of Stock Split
If IZM declared a 2 for 1 stock split, the
old shares would be voided and new
shares would be issued with the following
description:
 Common stock, $1 par value, 200,000
shares authorized, 20,000 shares issued
and outstanding.
 The total SE is still $100,000:

– Common stock
– Retained earnings
$20,000
80,000
The market price per outstanding share
would now be $25 per share.
 Note: No journal entry is necessary.

35
4. Stock Dividends vs Stock Splits
Going back to the original IZM information.
Assume instead that IZM declared a 100%
stock dividend.
First, prepare the JEs to record the
declaration and distribution of the stock
dividend for new shares (10,000 shares x
100% = 10,000 new shares x $2 per share
= $20,000):
Stock Dividends (RE) 20,000
Stock Div. Distributable 20,000
Stock Div. Distributable 20,000
Common Stock
20,000
36
4. Stock Dividends vs Stock Splits
Now note the new description for the stock
dividend:
 Common stock, $2 par value, 100,000 shares
authorized, 20,000 shares issued and
outstanding
 The total value in SE is still $100,000:
– Common Stock
$40,000
– Retained Earnings
60,000
 Note that the total market price per share would
change to $25 per share.
 Thus, a 2 for 1 stock split and a 100% stock
dividend have the same effect on:
– total stockholders’ equity and
– market price per share
37
4. Stock Dividends vs Stock Splits
However, a stock dividend requires a
journal entry, which changes the
components of SE (RE and CS).
 A stock split changes the description of the
shares, including the par value per share.
 Most companies use a stock split to
change the market price per share, but
some companies use the large stock
dividend to achieve the same result. This
action is called a “stock split effected in the
form of a dividend.”

38
4. Stock Dividends vs Stock Splits
To summarize the effects on IZM Company:
100% Stock
2 for 1
After:
Dividend
Stock Split
Total sh. outstanding 20,000 sh.
20,000 sh.
Par value per share
$2
$1
Market price per share
$25
$25
Total stockholders’ eq: $100,000
$100,000
General ledger results:
CS account
$ 40,000
$ 20,000
RE account
$ 60,000
$ 80,000
Reminder: CS was $20,000 and RE was $80,000
before the split or dividend ( see slide 35). Since the
stock dividend required journal entries (see slide 36),
the amounts for CS and RE changed. Since the
stock split does not require a journal entry, the
amounts for CS and RE do not change.
39
4. RE - Appropriations
Companies may choose to “restrict” a
portion of their RE for dividend payout.
 Reasons for this restriction may include
activities such as plans for corporate
expansion or plans for the retirement of
debt.
 The restriction does not create a cash
balance for these plans. It simply
indicates intentions.
 The restriction, or appropriation may be
indicated through disclosure, or through a
reclassification of retained earnings.

40
5. Other Comprehensive Income
Comprehensive Income is a term that was
defined in the Statements of Financial
Accounting Concepts (SFAC 6).
 It consists of all non-owner changes in
equity. This includes net income as we
have been defining revenues and
expenses throughout the semester, and it
also includes “Other Comprehensive
Income.”

41
5. Other Comprehensive Income
“Other Comprehensive Income” (OCI)
includes certain direct equity adjustments
that are not part of the current income
statement, but which may have eventual
effect on income.
 One of these adjustments was discussed
in this module: deferred compensation
expense.
 The amount is recorded in OCI, until the
effect is transferred to the income
statement.

42
5. Other Comprehensive Income




Another item in Other Comprehensive Income
is the Cumulative Translation Adjustment.
This adjustment occurs when a company owns
a foreign subsidiary, and must translate the
foreign subsidiary to U. S. dollars before
consolidating.
The adjustment would only be realized as part
of the income statement if the foreign
subsidiary was sold or liquidated for U.S.
dollars.
The adjustment can be an increase or
decrease, depending on the cumulative
direction of change in the exchange rate.
43
5. Other Comprehensive Income




Other items in Other Comprehensive Income
include:
Unrealized Gain/Loss on Available-for-Sale
Investments. These long term investments
are allowed to revalue each period up or down
to market. The revaluation causes a gain or
loss to be recognized (it is unrealized since the
investment has not been sold).
However, since the investment is long-term,
the gain or loss is NOT recognized in the
income statement. Instead, it is recognized
cumulatively in OCI, until the investment is
finally sold.
Similar treatment is given to certain kinds of
derivatives (a special form of investments).
44
5. Other Comprehensive Income



One other item that will be discussed comes from
a recent standard (SFAS 158), and is part of the
new requirement by FASB to fully recognize all
pension assets and liabilities in the balance
sheet.
However, FASB allows companies to defer
recognition of a portion of the pension
components, and spread the effects over future
periods. These components (costs, losses, and
gains) are deferred to OCI, until they are
recognized in future income. (More in Module 10.)
In the past, some companies recognized an OCI
adjustment for “Minimum Liability”, but this
requirement is no longer in effect (ignore
comment in your text).
45
6. Statement of Stockholders’ Equity
In this chapter, we have discussed the
Statement of Retained Earnings as the link
between the balance sheet and the income
statement.
 However, earlier chapters introduced the
Statement of Stockholders’ Equity, which
has become the default statement for large
companies in recent years.
 The Statement of Stockholders’ Equity
details the change in retained earnings,
including all the changes discussed in this
chapter, and it also shows the change
during the year in all of the stockholders’
equity accounts.

46
7. Convertible Securities

Certain types of stocks and bonds may affect
stockholders’ equity.
 Preferred stock may be issued with a convertible
privilege, which allows investors to convert to
common stock at a predetermined ratio. This
conversion is usually recorded at book value of
the preferred stock, and no cash is required in the
exchange.
 Convertible bonds allow the investor to convert
the bonds to common stock at a predetermined
ratio. The conversion is similar to that for
preferred stock, but in this case, liabilities go down
and equity goes up.
 These convertible securities will have an effect on
earnings per share calculations, particularly
diluted earnings per share (see Module 5).
47
8. Comprehensive Class Problem Stockholders’ Equity
Given the following SE balances for Company G at 1/1/013
Common stock, $10 par, 50,000 shares authorized,
20,000 shares issued and outstanding
$200,000
APIC on common stock
400,000
Retained earnings
400,000
During 2013, Company G had the following activity:
1. Net income for the year was $250,000.
2. Cash dividends of $2 per share were declared and paid on
February 1.
3. On June 1, Company G repurchased 2,000 shares of its
own stock at $20 per share (using the cost method).
4. On December 1, Company G reissued 500 shares of
treasury stock at $18 per share.
5. On December 15, Company G declared a 100% stock
dividend, to be distributed to all of its shareholders
(including treasury), on Jan. 15, 2014.
6. At Dec. 31, Company G recorded an AJE to revalue its
available for sale investments from $20,000 to $32,000. 48
Comprehensive Class Problem Stockholders’ Equity (continued)
Required:
A.Prepare journal entries for items 2 through 6
(item 1 would require detail information for
revenues and expenses to prepare - just
know that the credit is to retained earnings
for $250,000).
B.Prepare the Statement of Stockholders’
Equity for Company G for 2013.
C.Prepare the stockholders’ equity section of
the balance sheet for Company G for 2013,
including the appropriate description for the
common stock.
49
Comprehensive Class Problem - Solution
A.Journal entries
1.No entry required.
2.Calc: 20,000 x $2 = 40,000
3. Calc: 2,000 shares x $20 = $40,000
50
Comprehensive Class Problem - Solution
Part A: Journal Entries
4.Calc: 500 shares x $18 market = $9,000
500 shares x $20 cost = $10,000
5.Calc: 20,000 new shares x $10 par = $200,000
Note: in Item 5, the stock has not yet been distributed, so we
cannot credit common stock, or show it issued yet. This
“Stock Dividends Distributable” account is a related equity
account, and indicates that there are shares of stock to be
distributed in the future.
51
Comprehensive Class Problem - Solution
Part A: Journal Entries
6. Calc: value up $12,000
Note that the Unrealized Gain account is part
of stockholders’ equity (not the income
statement), and it is located as a separate
column called Other Comprehensive Income
(OCI) in the Statement of Stockholders’
Equity .
52
Comprehensive Class Problem - Solution
Part B: Statement of SE (in thousands)
CS CSDD APIC
Balance 1/1/13
$200
Net income
Cash dividends
Stock dividends
Purchase of TS
Reissue of TS
Revalue AFS Invest.
Balance, 12/31/13
$200
$200
$200
RE
OCI
TS
$400 $400
250
(40)
(200)
( 1)
$(40)
10
$400 $409
$12
$12 $(30)
Note: CSDD is Common Stock Dividends Distributable. When
shares distributed, then CS is increased.
Note: OCI is Other Comprehensive Income and reflects the
unrealized gain on Available-for -sale investment.
53
Comprehensive Class Problem - Solution
Part C: Stockholders’ Equity Section of B/S
Common stock, $10 par value, 50,000 shares
authorized, 20,000 shares issued,
18,500 shares outstanding
$
Common stock dividends distributable, 20,000 shares
Additional paid-in capital, common stock
Retained earnings
Other comprehensive income
Less: Treasury stock, 1,500 shares at cost
Total stockholders’ equity
200,000
200,000
400,000
409,000
12,000
(30,000)
$1,191,000
54