CHAPTER 18 : Shareholders’ Equity
LEARNING OBJECTIVES:
LO18-1 Describe the components of shareholders’ equity and explain how
they are reported in a statement of shareholders' equity.
LO18-2 Describe comprehensive income and its components.
LO18-3 Understand the corporate form of organization and the nature of
stock. (SELF-STUDY)
LO18-4 Record the issuance of shares when sold for cash and noncash
consideration.
LO18-5 Distinguish between accounting for retired shares and treasury
shares.
LO18-6 Describe retained earnings and distinguish it from paid-in capital.
LO18-7 Explain the basis of corporate dividends, including the similarities
and differences between cash and property dividends.
LO18-8 Explain stock dividends and stock splits and we account for them.
LO18-9 Discuss the primary differences between U.S. GAAP and IFRS with
respect to accounting for shareholders’ equity. (SELF-STUDY)
18-2
The Nature of Shareholders’ Equity
Assets – Liabilities = Shareholders’ Equity
Net Assets
Sources of
Shareholders’
Equity
Amounts earned
Amounts invested
by shareholders
Shareholders’ Equity
Paid-in Capital
Retained Earnings
Accumulated Other
Comprehensive Income
by corporation
Other
gains and
losses not
included in
net income
18-3
Financial Reporting Overview
Shareholders' Equity
Paid-in capital:
Captial stock:
Preferred stock - $100 par value; 1,000 shares
authorized; 400 shares issued and
outstanding
$ 40,000
Common stock - $10 par value; 60,000 shares
authorized; 20,000 shares issued and
outstanding
200,000
Additional paid-in capital in excess of par value
From issuance of preferred stock
10,000
From issuance of common stock
300,000
Total paid-in capital
$ 550,000
Retained earnings
121,500
Accumulated other comprehensive income:
Net unrealized holding gains (losses) on investments
(35,000)
Gains (losses) from foreign currency translation
22,000
(13,000)
Treasury stock (at cost)
(10,000)
Total shareholders' equity
$ 648,500
Accumulated Other
Comprehensive Income
18-4
Accumulated other comprehensive income
includes four types of gains and losses
not included in net income.
Net holding
gains (losses) on
investments.
Gains (losses)
from and
amendments to
postretirement
benefit plans.
Deferred gains
(losses) from
derivatives.
Gains (losses)
from foreign
currency
translations.
Accumulated Other
Comprehensive Income
Comprehensive income is reported periodically as it is
created and also is reported as a cumulative amount.
There are 2 options for
reporting comprehensive
income created during the
reporting period.
As an additional
section of the
income
statement.
The accumulated amount of
comprehensive income is
reported as a separate item
of shareholders’ equity in
the balance sheet.
As a separate
statement
immediately following
the income statement
18-5
18-6
The Corporate Organization (SELF STUDY)
Advantages of a corporation
Continuous
existence
Easy
ownership
transfer
Easy to
raise capital
Limited
liability
Disadvantages of a corporation
Double
taxation
Government
regulation
Types of Corporations (SELF STUDY)
Not-for-profit corporations include
hospitals, charities, and government
agencies such as FDIC.
Publicly-held corporations
whose shares are widely
owned by the general public.
Privately-held corporations
whose shares are owned by
only a few individuals.
18-7
18-8
Hybrid Organizations (SELF STUDY)
S Corporation


Limited liability protection of a corporation.
Maximum number of owners.
Limited liability company



Limited liability protection of a corporation.
All owners may be involved in management
without losing limited liability protection.
No limit on number of owners.
Limited liability partnership

Owners are liable for their own actions but not
entirely liable for actions of other partners.
Double
taxation
avoided.
The Model Business Corporation Act
(SELF STUDY)
Nature and location of business activities.
 Number and classes of shares authorized.

Articles of incorporation
are filed with the state.
State issues a
corporate charter.
Shares of
stock issued.
Board of directors
appoint officers.
Board of directors
elected by
shareholders.
18-9
18-10
Fundamental Share Rights
Right to vote.
Preemptive
right to maintain
percentage
ownership.
Right to share
in profits when
dividends are
declared.
Right to share
in distribution of
assets if company
is liquidated.
Authorized, Issued, and
Outstanding Shares
Authorized shares are the maximum
number of shares of capital stock that
can be sold to the public.
Issued
shares are
authorized
shares of
stock that
have been
sold.
Unissued
shares are
authorized
shares of
stock that
never have
been sold.
18-11
Authorized, Issued, and
Outstanding Shares
Outstanding shares are
issued shares that are
owned by stockholders.
Authorized
Shares
Issued
Shares
Retired shares
have the same
status as
authorized but
unissued shares.
18-12
Outstanding
Shares
Treasury
Shares
Retired
Shares
Unissued
Shares
Treasury shares are
issued shares that have
been reacquired by the
corporation.
18-13
Capital Stock


Par value stock
Dollar amount per share is
stated in the corporate
charter.
Par value has no
relationship to market
value.


No-par stock
Dollar amount per share
is not designated in
corporate charter.
Corporations can assign a
stated value per share
(treated as if par value).
Legal capital is . . .
 The portion of shareholders’ equity that must be contributed
to the firm when stock is issued.
 The amount of capital, required by state law, that must remain
invested in the business.
 Refers to par value, stated value, or full amount paid for nopar stock.
18-14
Capital Stock
Common stock is the basic voting stock of the
corporation. It ranks after preferred stock for dividend
and liquidation distribution. Dividends are determined
by the board of directors.
Usually has a
par or stated value.
Generally does not
have voting rights.
Preferred
Stock
Dividend and liquidation
preference over
common stock.
May be convertible,
callable, and/or
redeemable.
Preferred Stock Dividends



Are usually stated as a percentage of the par
or stated value.
May be cumulative or noncumulative.
May be partially participating, fully participating,
or nonparticipating.
Unpaid Dividends on
Cumulative PREFERRED stocks
must be paid in full
before any distributions to common stock.
Dividends in arrears are not liabilities, but the per share
and aggregate amounts must be disclosed.
Brief Exercise 18–5
18-15
Brief Exercise 18–5
MLS’s common shareholders’ will receive dividends of $18 million as a
result of the 2013 distribution.
Preferred
2011
2012
2013
$20 million*
20 million**
32 million***
Unpaid Preferred
Dividends
$4 million
$4 million
$0
Common
$0
$0
$18 million (remainder)
Preferred Dividend Preference = $400 Million * 6% = $24 million
* $24 - $20 = $4 million dividends in arrears.
** $24 - $20 = $4 million dividends in arrears.
*** $8 million dividends in arrears plus the $24 million current preference.
18-17
Shares Issued for Cash
10,000 shares of stock are issued for $100,000 cash.
$1 Par
Value
Cash .......................................................
Common stock, par value ..............
Paid-in capital – excess of par ……
100,000
10,000
90,000
To record issue of common stock.
No Par
Value
No Par,
$1 Stated
Value
Cash .......................................................
Common stock .............................
100,000
100,000
To record issue of common stock.
Cash ................................................................... 100,000
Common stock, stated value .....................
10,000
Paid-in capital – excess of stated value ….
90,000
To record issue of common stock.
Shares Issued for
Noncash Consideration
Apply the general valuation principle by using fair
value of stock given up or fair value of asset
received, whichever is more clearly evident.
If market values cannot be determined, use
appraised values.
18-18
More Than One Security
Issued for a Single Price


Allocate the lump-sum received based on the relative fair
values of the two securities.
If only one fair value is known, allocate a portion of the lumpsum received based on that fair value and allocate the
remainder to the other security.
Toys Inc. issued 5,000 shares of common stock, $10 par value,
and 3,000 shares of preferred stock, $5 par value, for $450,000.
The market values of the common stock and
preferred stock were $55 and $75, respectively.
Calculate the additional paid-in
capital for each class of stock.
18-19
18-20
More Than One Security Issued
for a Single Price
Common Stock
Preferred Stock
Market*
$ 275,000
225,000
%
Allocation**
Par^
55% $ 247,500 $ 50,000
45%
202,500
15,000
Excess^^
$ 197,500
187,500
Total
$ 500,000
100% $ 450,000
$ 385,000
$ 65,000
* Market Value:
Common: $55 × 5,000 shares
Preferred: $75 × 3,000 shares
^ Par Value:
Common: $10 × 5,000 shares
Preferred: $5 × 3,000 shares
**Allocation:
Common: $450,000 × 55%
Preferred: $450,000 × 45%
^^Excess:
Common: $247,500 - $50,000 par
Preferred: $202,500 - $15,000 par
Cash ............................................................................
Common stock, $10 par .....................................
Paid-in capital – excess of par common ………..
Preferred stock, $5 par
Paid-in capital – excess of par preferred ……….
To record issue of common and preferred stock.
450,000
50,000
197,500
15,000
187,500
Share Issue Costs
Registration fees
 Underwriter commissions
 Printing and clerical costs
 Legal and accounting fees
 Promotional costs

Share issue costs reduce net proceeds
from selling shares, resulting in a lower
amount of additional paid-in capital.
EXERCISE 7
18-21
Exercise 18–7
Requirement 1 ($ in millions):
Cash ($424 million – 2 million)
422
Common stock (15 million shares at $1 par per share)
Paid-in capital—excess of par (difference)
15
407
Requirement 2
In recording the sale of shares above, the cost of services related to the sale
reduced the net proceeds from selling the shares.
Since paid-in capital—excess of par is credited for the excess of the proceeds
over the par amount of the shares sold, the effect of share issue costs is to
reduce the amount credited to that account.
On the other hand, the costs associated with a debt issue are recorded in
a separate “debt issue costs” account and amortized to expense over the
life of the debt.
18-23
Share Buybacks
A corporation might reacquire shares of its stock to . . .
 support the market price.
Companies can account
 increase earnings per share.
for the reacquired
 distribute in stock option plans.
shares by retiring them
 issue as a stock dividend.
or by holding them as
treasury shares.
 use in mergers and acquisitions.
 thwart takeover attempts.
18-24
Accounting for Retired Shares
When shares are formally retired, we reduce the same capital
accounts that were increased when the shares were issued –
common or preferred stock, and additional paid-in capital.
Price paid is less than issue price.
5,000 shares of $2 par value stock that were issued
for $20 per share are reacquired for $17 per share.
Common stock ............................................................
Paid-in capital – excess of par common ……………....
Paid-in capital – share repurchase ……………..
Cash ………………………………………………..
To record repurchase and retirement of common stock.
10,000
90,000
15,000
85,000
18-25
Accounting for Retired Shares
Price paid is more than issue price.
5,000 shares of $2 par value stock that were issued
for $20 per share are reacquired for $25 per share.
Common stock ............................................................
Paid-in capital – excess of par common ……………….
Paid-in capital – share repurchase ……………………..
Cash ………………………………………………..
10,000
90,000
25,000
125,000
To record repurchase and retirement of common stock.
Reduce Retained Earnings if the Paid-in capital—share
repurchase account balance is insufficient.
18-26
Accounting for Treasury Stock
Treasury stock usually does not have:
Voting rights.
Dividend rights.
Preemptive rights.
Liquidation rights.
Treasury stock is reported as an unallocated reduction
of total Shareholders’ Equity.
Acquisition of Treasury Stock
Recorded at cost to acquire.
Resale of Treasury Stock
Treasury Stock credited for cost.
Difference between cost and issuance price is (generally)
recorded in paid-in capital—share repurchase.
18-27
Accounting for Treasury Stock
On 5/1/12, Photos-in-a-Second reacquired 3,000 shares of its
common stock at $55 per share. On 12/3/13, Photos-in-a-Second
reissued 1,000 shares of the stock at $75 per share. Which of the
following would be included in the 12/3/13 entry?
a. Credit Cash for $165,000.
b. Debit Treasury Stock for $75,000.
c. Credit Treasury Stock for $55,000.
d. Credit Cash for $75,000.
May 1, 2012:
Treasury stock ..............................................
Cash ...................................................
165,000
165,000
To record purchase of treasury stock.
December 3, 2013:
Cash .............................................................
Treasury stock ....................................
Paid-in capital – share repurchase ….
To record reissue of treasury stock.
75,000
55,000
20,000
18-28
Where We’re Headed
The FASB and IASB are working to establish a common standard for
presenting information in the financial statements, An important part
of the proposal involves the organization of elements of the balance
sheet, statement of comprehensive income, and statement of cash
flows into a common set of classifications.
A key feature of the new format is that each of the financial
statements will include classifications by operating, investing, and
financing activities (similar to the current statement of cash flows).
Operating and investing activities will be included within a new
category, “business” activities. Each statement also will include three
additional groupings: discontinued operations, income taxes, and multicategory transactions (if needed).
18-29
Retained Earnings
Represents the undistributed earnings of the
company since its inception.
Balance January 1, 2013
Net income
Cash dividends
Balance December 31, 2013


$ 106,500
25,000
(10,000)
$ 121,500
The statement of retained earnings may also contain the
correction of an accounting error that occurred in the
financial statements of a prior period, called a prior period
adjustment.
Any restrictions on retained earnings must be disclosed in
the notes to the financial statements.
18-30
Accounting for Cash Dividends
Declared by board of
directors.
Not legally
required.
Creates liability at
declaration.
Requires sufficient
Retained Earnings and
Cash.
Declaration date


Board of directors declares a $10,000 cash dividend.
Record a liability.
Declaration Date:
Retained earnings ........................................
Dividends payable ..............................
To record declaration of cash dividend.
10,000
10,000
18-31
Dividend Dates
Ex-dividend date
The first day the shares trade without the right to
receive the declared dividend. (No entry)
Date of Record
Stockholders holding shares on this date will receive
the dividend. (No entry)
Date of Payment
Record the dividend payment to stockholders.
Date of Payment:
Dividends payable ........................................
Cash ………………..............................
To record payment of cash dividend.
10,000
10,000
18-32
Property Dividends
Distributions of noncash assets.
 Record at fair value of
noncash asset.
 Recognize gain or loss
for difference between
book value and fair
value.

18-33
Accounting for Stock Dividends
Distribution of additional shares of stock to owners.
No change in total
stockholders’ equity.
No change in
par values.
All stockholders retain same
percentage ownership.
Small
Large
Stock dividend < 25%
Stock dividend > 25%
Record at current fair
value of stock.
Record at par
value of stock.
18-34
Accounting for Stock Dividends
CarCo declares and distributes a 20% stock
dividend on 5 million common shares. Par value
is $1 and market value is $20. The required
journal entry would be:
Retained earnings .....................................................
Common stock ………………………………….
Paid-in capital – excess of par common ……..
20,000,000
1,000,000
19,000,000
To record declaration and distribution of small stock dividend.
5,000,000 shares × 20 % = 1,000,000 shares issued × $20 = $20,000,000
18-35
Stock Splits
Stock splits change the par value per share and the number of
shares outstanding, but the total par value is unchanged, and no
journal entry is required.
Assume that a corporation had 3,000 shares of
$2 par value common stock outstanding before
a 2–for–1 stock split.
Before
Split
Common Stock Shares
After
Split
3,000
Par Value per Share
$
2.00
Total Par Value
$ 6,000
6,000
$
1.00
$ 6,000
Increase
Decrease
No
Change
18-36
Stock Splits Effected in the
Form of Large Stock Dividends
Matrix Inc. declares and distributes a 2-for-1 stock split
effected in the form of a 100% stock dividend. The
company has 1,000,000, $1 par value common stock
outstanding. The stock is trading in the open market for
$14 per share. The per share par value of the shares is not
to be changed.
Paid-in capital – excess of par common ….................
Common stock ……………..…………………….
To record declaration and distribution of 2-for-1 stock
split effected in the form of a 100% stock dividend.
1,000,000
1,000,000
18-37
U.S. GAAP vs. IFRS
Terminology Differences
Capital stock:
 Common stock.
 Preferred stock.
 Paid‐in capital—excess of
par, common.
 Paid‐in capital—excess of
par, preferred.
Share capital:
 Ordinary shares.
 Preference shares.
 Share premium, ordinary
shares.
 Share premium, preference
shares.
18-38
U.S. GAAP vs. IFRS
Terminology Differences

Accumulated other
comprehensive income:







Net gains (losses) on
investment ― AOCI.
Net gains (losses) foreign
currency translation —AOCI.
Fair value adjustments not
permitted.
Retained earnings.
Total shareholders’ equity.
Presented after liabilities
Reserves:

Investment revaluation
reserve.
Translation reserve.

Revaluation reserve.

Retained earnings.



Total equity.
Often presented before liabilities.
18-39
U.S. GAAP vs. IFRS
Distinction between Debt and Equity
for Preferred Stock

Preferred stock normally is
reported as equity, but is reported
as debt with the dividends
reported in the income statement
as interest expense if it is
“mandatorily redeemable”
preferred stock.

Most non-mandatorily redeemable
preferred stock (preference
shares) also is reported as debt as
well as some preference shares
that aren’t redeemable. Under
IFRS (IAS No. 32), the critical
feature that distinguishes a liability
is if the issuer is or can be
required to deliver cash (or
another financial instrument) to
the holder.
18-40
Appendix 18 ─ NOT COVERED
18-41
End of Chapter 18