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Chapter 12
Shareholders’ Equity
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Chapter 12: Shareholders’ Equity
How to Finance the Corporation?
 Borrow
– Notes, Bonds, Leases
– The debt holders are legally entitled to repayment of
their principal and interest claims

Issue Equity
– Common and Preferred Stock
– The shareholders, as owners, have voting rights,
limited liability, and a residual interest in the corporate
assets

Retained Earnings
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Relative Importance of Liabilities,
Capital, and Retained Earnings
(% of total assets)
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Debt versus Equity
Debt
Formal legal contract
Fixed maturity date
Fixed periodic payments
Security in case of default
No voice in management
Interest expense deductible
Equity
No legal contract
No fixed maturity date
Discretionary dividends
Residual asset interest
Voting rights - common
Dividends not deductible
Double taxation
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Distinctions between Debt and Equity
Interested Party
Debt
Equity
Investors /
Creditors
Lower investment risk Higher investment risk
Fixed cash receipts
Variable cash receipts
Management
Contractual future
cash payments
Dividends are
discretionary
Effects on credit
rating
Interest is tax
deductible
Effects of dilution/
takeover
Dividends are not
tax deductible
Accountants/
Auditors
Shareholders’ equity
Liabilities section
of the balance sheet
of the balance sheet
No income statement
Income statement
effects from equity
effects from debt
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Preferred Stock vs Common Stock
Advantages
Preferred Stock
Common Stock
Preference over common in
liquidation
Voting Rights
Stated dividend
Rights to residual profits
(after preferred)
Preference over common in
dividend payout
Disadvantages
Subordinate to debt in liquidation
Last in liquidation
Stated dividend can be skipped
No guaranteed return
No voting rights (versus common)
Debt or Equity?
Components of both
Usually classified as equity
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Sample Co. Shareholders’ 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 items
(unrealized loss on AFS securities)
(2,000)
Total Shareholders’ Equity
$131,000
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Journal Entries-Sample Co.
Now, using Sample Company information,
record the following additional issues of
common (CS) and preferred stock (PS):
Issued 100 shares of PS at $102 per share:
Cash (100 x $102)
10,200
PS (100 x $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
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Treasury Stock






Created when a company buys back shares of its own
common stock.
Reasons for buyback?
The debit balance account called “Treasury Stock” is reported
in shareholders’ equity as a contra account to SE.
– Note: Treasury Stock is 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.
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TS Example from Sample Co.
Look again at the information for Sample Co.
Note that Sample Company has 5,000 shares of
TS at a total cost of $6,000, or a cost of $1.20
per share. The journal entry to record that
purchase would have been:
TS
6,000
Cash
6,000
Note that Sample Company also has APIC - TS of
$2,000 in the balance sheet. This must be from
previous TS transactions, where the TS was
purchased, then reissued for more than original
cost. All that remains of those transactions is the
APIC -TS.
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Sample Co. Shareholders’ 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 items
(unrealized loss on AFS securities)
(2,000)
Total Shareholders’ Equity
$131,000
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TS - Example Problem
Tiger Corporation has 100,000 shares of $1 par
value stock authorized, issued and outstanding at
January 1, 2007. 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 2007, Tiger Corp.
repurchases 10,000 shares of its own stock at $7
per share. In July of 2007, Tiger Corp. reissues
2,000 shares of the treasury stock for $8 per share.
In December of 2007, Tiger Corp. reissues the
remaining 8,000 shares for $6 per share. Prepare
the journal entries for 2007 regarding the treasury
stock.
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TS Example -Journal Entries
Feb: repurchase 10,000 sh. @ $7 =
$70,000.
TS
70,000
Cash
70,000
July: reissue 2,000 sh @ $ 8 = $16,000
(cost = 2,000 @ $7 = 14,000)
Cash
16,000
TS
APIC - TS
14,000
2,000
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TS Example -Journal Entries
Dec: reissue 8,000 sh. @ $ 6 = $48,000
(cost = 8,000 sh.@ $7 = 56,000)
Cash
48,000
APIC - TS (1)
2,000
RE (2)
6,000
TS
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).
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Retained Earnings
We will be expanding the basic retained earnings
formula in this chapter. Now the Statement of
Retained Earnings will include the following:
RE, beginning (unadjusted)
xx
Add/Subtract: Prior period adjustment xx
RE, beginning (restated)
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
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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.
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Example of Stock Split
If IZM declared a 2 for 1 stock split, the old
shares would be turned in 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.

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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
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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 shareholders’ equity and
– market price per share
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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 shareholders’ 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. Since the stock dividend
required journal entries, 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.
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Other Comprehensive Income
“Other Comprehensive Income” includes
certain direct equity adjustments that are
not part of the current income statement,
but which may have an eventual effect on
income.
 We already discussed one of these direct
equity adjustments when reviewing
Available-for-sale Investments. We found
that any unrealized gains/losses from
revaluation to market are shown in SE
(as “other comprehensive income”) rather
than on the income statement.

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Comprehensive Class Problem Shareholders’ Equity
Given the following SE balances for Company G at 1/1/07:
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 2007, 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, 2008.
6. At Dec. 31, Company G recorded an AJE to revalue its
available for sale investments from $20,000 to $32,000. 23
Comprehensive Class Problem Shareholders’ Equity (continued)
Required:
A. Prepare journal entries for items 2 through
6 (item 1 would require detailed information
for revenues and expenses to prepare - just
know that the credit is to retained earnings
for $250,000).
B. the Statement of Stockholders’ Equity for
Company G for 2007.
C. Prepare the stockholders’ equity section of
the balance sheet for Company G for 2007,
including the appropriate description for the
common stock.
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Comprehensive Class Problem - Solution
A. Journal entries
1. No entry required.
2. Calc: 20,000 x $2 = 40,000
Cash Dividends (RE) 40,000
Dividends Payable
40,000
Dividends Payable
40,000
Cash
40,000
3. Calc: 2,000 shares x $20 = $40,000
Treasury Stock
40,000
Cash
40,000
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Comprehensive Class Problem - Solution
Part A: Journal Entries
4. Calc: 500 shares x $18 market = $9,000
500 shares x $20 cost = $10,000
Cash
Retained Earnings
Treasury Stock
9,000
1,000
market
plug
10,000 cost
5. Calc: 20,000 new shares x $10 par = $200,000
Stock Dividend (RE) 200,000
Stock Div. Distributable 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.
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Comprehensive Class Problem - Solution
Part A: Journal Entries
6. Calc: value up $12,000
AFS Investment
12,000
Unrealized Gain on AFS 12,000
Note that the Unrealized Gain account is part
of shareholders’ equity (not the income
statement), and it is located at the bottom of
the shareholders’ equity section of the
balance sheet, in Other Comprehensive
Income (OCI).
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Comprehensive Class Problem - Solution
Part B: Statement of SE (in thousands)
CS CSDD APIC
Balance 1/1/07
$200
Net income
Cash dividends
Stock dividends
Purchase of TS
Reissue of TS
Revalue AFS Invest.
Balance, 12/31/07
$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 are distributed, then CS is increased.
Note: OCI is Other Comprehensive Income and reflects the
unrealized gain on Available-for-sale investments.
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Comprehensive Class Problem - Solution
Part C: Shareholders’ 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
(unrealized gain on AFS investment)
Less: Treasury stock, 1,500 shares at cost
Total shareholders’ equity
200,000
200,000
400,000
409,000
12,000
(30,000)
$1,191,000
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