Module 8
Reporting and
Analyzing Owner
Financing Activities
Reporting and Analyzing Owner
Financing Activities
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The assets of a company must be financed
from one of two sources:
1.
2.

It borrows funds
It obtains capital from its shareholders.
On average, companies obtain about half of
their capital from borrowed sources and the
other half from shareholder investment.
Debt vs. Equity
Debt
Formal legal contract
Fixed maturity date
Fixed periodic payments
Security in case of default
No voice in management
Interest expense
Equity
No legal contract
No fixed maturity date
Discretionary dividends
Residual asset interest
Vote - board of directors
Dividends reduce RE
Reporting and Analyzing Owner
Financing Activities
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Stockholders’ equity is accounted for at
historical cost, just like assets and liabilities.
When a company sells stock to the investing
public, it records the receipt of cash and the
increase in stockholders’ equity, representing
increased investment in the company by the
shareholders.
Reporting and Analyzing Owner
Financing Activities
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There is an important difference between the
accounting for stockholders’ equity and the
accounting for transactions involving assets
and liabilities: there is never any gain or
loss recorded on the purchase and sale of
stock or the payment of dividends.
Instead, these “gains” and “losses” are
reflected in increases (decreases) in the paidin-capital component of stockholders’ equity.
Components of Paid-in-Capital
Stockholders’ Equity
Total stockholders’ equity is divided into two
major components:
1.
Paid-in-capital –This section is comprised of paid-incapital (preferred stock and common stock), and
additional paid-in-capital. Both of these accounts are
generically referred to as paid-in-capital.
Treasury stock – This account represents the amounts
paid to repurchase shares of stock from investors, net of
the proceeds from the resale of those shares.
Stockholders’ Equity
Total stockholders’ equity is divided into two major
components:
2.
Earned capital – The retained earnings account
represents the cumulative profits of the company
that have not yet been paid out to shareholders in
the form of dividends. Accumulated other
comprehensive income (OCI) includes a number of
changes to stockholders’ equity that have not
impacted earnings and are, therefore, not reflected
in the retained earnings account.
Types of Stock
There are two often classes of
stock:

1.
2.
Common Stock
Preferred Stock
Some More Jargon

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Authorized, Issued, Outstanding
Market Value
Book Value
Par Value
Preferred Stock
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Preferred stock generally has some
preference, or priority, with respect to
common stock.
Preferred Stock

Two common preferences are:
1.
2.
Dividend preference – preferred shareholders
receive dividends on their shares before
common shareholders do.
Liquidation preference – in the event of the
failure of the company, preferred shareholders
will receive payment in full before common
shareholders. This liquidation preference makes
preferred shares less risky to own in the event of
business failure than common shares.
Types of Preferred Stock

Cumulative preferred: dividends in arrears
and current year’s dividends must be paid
before common dividends can be paid.

Convertible preferred: convertible into a
specified number of shares of common.
Accounting for Stock Transactions: Sale
of Stock
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From an accounting standpoint, cash increases by the
number of shares sold multiplied by the market price
of the stock on the date of sale.
Equity also increases by the same amount, and this
increase is reflected in the paid-in-capital accounts.
Assuming that common stock is issued, the common
stock account increases by the number of shares sold
multiplied by the par value and the additional paid-incapital account increases for the remainder.
Sale of Stock Illustrated

To illustrate, assume that Pfizer issues 10,000 shares of
$0.05 par value common stock at a market price of $43
per share. The sale of stock has the following effects on
the balance sheet:
1. Cash increases by $430,000 (10,000 shares x $43)
2. Common stock increases by the par value of the shares issued (10,000
shares x $0.05 = $500)
3. Additional paid-in capital increases for the remainder of the purchase price
Shareholder Sells Stock to Another
Party

No affect on company accounts.

Company notes change of owners and
address of owners.
Treasury Stock

Corporation’s own stock that has been issued
and reacquired.

Reasons to reacquire own stock:

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Limited investment opportunities.
To increase stock price.
To increase EPS.
To issue stock bonus to employees.
To prevent hostile takeover.
Accounting for Stock Transactions:
Repurchase of Stock
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When common stock is repurchased, both
assets (cash) and stockholders’ equity
decrease by the purchase price.
The reduction in stockholders’ equity is
accomplished by increasing a contra-equity
account called treasury stock.
Repurchase of Stock Illustrated

To illustrate, assume that 3,000 of the shares issued
above for $43 are subsequently repurchased for
$40. The repurchase will have the following effects
on the balance sheet:
Repurchase of Stock Illustrated

Now assume that these 3,000 shares are
subsequently resold for $42. The resale of the
treasury stock has the following effects on the
balance sheet:
Retained Earnings

Cumulative net income earned since
inception of company less cumulative total
dividends paid.
Cash Dividends
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Why pay dividends?
At declaration (vote of the BOD): decrease
RE and increase Dividends Payable.
At date of record, figure out who is entitled to
the dividend, no entry.
At payment, reduce Dividends payable and
reduce Cash.
Dividends
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Companies pay dividends out of retained profits.
Dividends are usually paid in cash on a quarterly
basis.
Stock analysts closely monitor the payment of
dividends.
It is generally perceived that the level of dividend
payments is related to long-term expected core
earnings.
As a result, dividend increases are usually
accompanied by stock price increases, and
companies rarely reduce their dividends unless
absolutely necessary.
Dividend reductions are, understandably, greeted
with significant stock price declines.
Accounting for Dividends: Cash
Dividends

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The accounting for cash dividends is straightforward. Both
cash and retained earnings are reduced by the amount of the
cash dividends paid.
In 2003, Pfizer paid $4.771 billion of cash dividends on its
common shares The payment of these dividends had the
following effects on its financial statements:
Stock Dividends

Increases every shareholders’ interest by the
same proportion of shares, say 5%.

Have you really received anything?
Accounting for Dividends: Stock
Dividends
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Although most dividends are paid in cash,
dividends can also be paid in the form of the
company’s stock.
In this case, retained earnings are reduced
and paid-in-capital is increased.
In addition, the amount by which retained
earnings are reduced depends on the
proportion of the outstanding shares
distributed.
Stock Split

Each shareholder receives a multiple of
shares previously held.

(As in a stock dividend,) no change in total
shareholders’ equity.
Comprehensive Income

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Comprehensive Income includes all recognized
changes in equity that occur during a period except
those resulting from investments by owners and
distributions to owners.
Thus, included in comprehensive income but
excluded from net income are foreign currency
adjustments, unrealized changes in the fair value of
available-for-sale securities, minimum pension
liability adjustments, and changes in the market
values of certain derivative investments.
Pfizer’s Statement of Stockholders’ Equity