Chapter 11: Stockholders’ Equity
1.Debt versus equity
2.Preferred stock
3.Common stock
4.Accounting for preferred and common stock
5.Treasury stock
6.Retained Earnings and dividends
7. Statement of stockholders’ equity
1. Debt versus Equity
Fixed maturity date No fixed maturity date
Fixed periodic payments Discretionary dividends
Security in case of default Residual asset interest
No voice in management Voting rights - common
Formal legal contract
No legal contract
Interest expense deductible
Dividends not deductible
Double taxation
2. 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
3. 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
4. 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. 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.
4. 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 (next slide) illustrates many of the components of SE
discussed in this chapter.
4.Sample Co. Stockholders’ Equity
Common stock, $1 par value, 500,000 shares
authorized, 80,000 shares issued, and
75,000 shares outstanding
$ 80,000
Preferred stock, $100 par value, 1,000 shares
authorized, 100 shares issued and
outstanding
10,000
Paid in capital on common
Paid in capital on preferred
25,000
$ 20,000
5,000
Retained earnings
22,000
Less: Treasury stock, 5,000 shares (at cost)
(6,000)
Total Stockholders’ Equity
$131,000
4. 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:
Issued 500 shares of CS at $5 per share:
5. 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.
5. 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.
5. 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)
5. 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.
5. TS - Example Problem
TT Corporation has 100,000 shares of $1 par value stock authorized,
issued and outstanding at January 1, 2008. 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 2008, TT Corp. repurchases 10,000
shares of its own stock at $7 per share. In July of 2008, TT Corp.
reissues 2,000 shares of the treasury stock for $8 per share. In
December of 2008, TT Corp. reissues the remaining 8,000 shares
for $6 per share. Prepare the journal entries for 2008 regarding the
treasury stock.
5. 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)
5. 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).
6. Retained Earnings - Cash Dividends
As cash dividends are declared:
Dividends (RE) - common xx
Dividends (RE)- preferred xx
Dividends Payable
As cash dividends are paid:
Dividends Payable
xx
xx
Cash
xx
Preferred dividends may be issued with extra privileges such as
“cumulative” and “participating.
Cumulative preferred dividends that are skipped in a particular year
must be settled before any dividends are paid to common shares.
Participating preferred stock may receive a cash dividend in excess
of its stated amount.
7. 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.