Additional
Stockholders’ Equity
Transactions and
Income Disclosures
© Copyright Doug Hillman 1999
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Retained Earnings
Cumulative net income of past years
minus net losses and dividends declared
during those years
 Primary factors affecting retained
earnings
› Net income or loss
› Restrictions of retained earnings
› Prior period adjustments
› Dividends

© Copyright Doug Hillman 1999
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Restrictions on Retained
Earnings
Tells the financial statement reader that
company may not pay out this part of
retained earnings as dividends
 Required restrictions
› To comply with legal or contractual
limits on dividend distribution
 Voluntary
› To show reasons why management
wishes to restrict dividends

© Copyright Doug Hillman 1999
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Prior Period Adjustment
An error in preparing financial
statements in one accounting period not
discovered until a later period
 Treat correction of error, if material, as
adjustment of beginning retained
earnings
› Adjusts affected balance sheet
account
› Adjusts beginning retained earnings

© Copyright Doug Hillman 1999
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Dividends
Distribution of cash, stock, or other
corporate assets to stockholders
 Declaration decreases retained earnings
 When board of directors takes formal
action, declaration, dividend immediately
becomes liability

© Copyright Doug Hillman 1999
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Cash Dividend
Date of declaration
› Increase Dividends - a nominal
account closed to Retained Earnings
› Increase Dividends Payable
 Date of record
› No entry
› Determines persons who will receive
dividend
› Stock sold after is sold ex-dividend

© Copyright Doug Hillman 1999
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Cash Dividend
Date of payment
› Decreases Cash
› Decreases Dividends Payable
 Cumulative preferred in arrears
› First must pay arrearages
› Then pay current period preferred
› Then common is entitled to dividends

© Copyright Doug Hillman 1999
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Stock Dividends
Issuance of additional shares of
authorized stock
 Reasons
› Need to conserve cash
› Give measure of company’s success
› Increase permanent capitalization
› Decrease market price

© Copyright Doug Hillman 1999
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Small Stock Dividend
Involves less than 20-25% of previously
outstanding shares
 Transfer from retained earnings to paidin capital an amount equal to market
value of shares
 Reasoning is that small stock dividends
do not decrease market value
significantly

© Copyright Doug Hillman 1999
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Small Stock Dividend

Date of declaration
› Increase Stock Dividends , a nominal
account closed to Retained Earnings,
for market value
› Increase Stock Dividends to be Issued
for par value
› Increase Paid-in Capital-Excess Over
Par for difference
© Copyright Doug Hillman 1999
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Small Stock Dividend
Stock Dividends to be Issued appears in
paid-in capital
 Date of payment
› Decrease Stock Dividends to be
Issued
› Increase Stock

© Copyright Doug Hillman 1999
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Large Stock Dividend
Involves more than 20-25% of
previously outstanding shares
 Transfer from retained earnings to paidin capital an amount equal to par value
of shares
 Reasoning is that large stock dividend
should decrease market value

© Copyright Doug Hillman 1999
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Large Stock Dividend
Date of declaration
› Increase Stock Dividends , a nominal
account closed to Retained Earnings,
for par value
› Increase Stock Dividends to be Issued
for par value
 Stock Dividends to be Issued appears in
paid-in capital

© Copyright Doug Hillman 1999
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Large Stock Dividend

Date of payment
› Decrease Stock Dividends to be
Issued
› Increase Stock
© Copyright Doug Hillman 1999
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Effect of Stock Dividend

Small stock dividend
› Increase paid-in capital by market
value of shares issued in dividend
› Decreases retained earnings by
market value of shares issued in
dividend
© Copyright Doug Hillman 1999
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Effect of Stock Dividend
Large stock dividend
› Increases paid-in capital by par value
of shares issued in dividend
› Decreases retained earnings by par
value of shares issued in dividend
 Capitalizes (makes permanent) some of
retained earnings

© Copyright Doug Hillman 1999
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Stock Split
Decreases the par or stated value per
share and increases number of shares
issued proportionally
 Total paid-in capital remains the same
 Total retained earnings remains the
same
 Market value of shares decreases
proportionally

© Copyright Doug Hillman 1999
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Treasury Stock
Shares of own stock reacquired by
corporation
 Acquisition reduces assets and
stockholders’ equity
 Shown as deduction from stockholders’
equity

© Copyright Doug Hillman 1999
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Treasury Stock

Acquisition
› Increases contra owners’ equity
account Treasury Stock by cost
› Decreases Cash
© Copyright Doug Hillman 1999
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Treasury Stock

Reissuance above cost
› Increases cash by proceeds
› Decreases Treasury Stock by cost
› Increases Paid-in Capital from
Treasury Stock Transactions by
difference
© Copyright Doug Hillman 1999
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Treasury Stock

Reissuance below cost
› Increases cash by proceeds
› Decreases Treasury Stock by cost
› Decreases Paid-in Capital from
Treasury Stock Transactions by
difference
© Copyright Doug Hillman 1999
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Treasury Stock

Reissuance below cost
› If Paid-in Capital from Treasury Stock
Transactions does not exist
–decrease any paid-in capital from
same class of stock
–retained earnings
© Copyright Doug Hillman 1999
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Book Value of Common Stock
Divide stockholders’ equity available to
common stockholders by number of
shares outstanding
 When more than one class of stock is
outstanding
› subtract liquidation claims of
noncommon from total stockholders’
equity to determine equity available to
common

© Copyright Doug Hillman 1999
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Presentation of Stockholders’
Equity
Paid-in capital
Stock
Common stock, $1 par,
10,000 sh authorized,
8,000 sh issued
Additional paid-in capital
Paid-in capital-excess over
par, common
Total paid-in capital
© Copyright Doug Hillman 1999
$ 8,000
24,000
$32,000
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Presentation of Stockholders’
Equity
Retained earnings
Restricted for plant
expansion
$10,000
Unrestricted
50,000
Total retained earnings
60,000
Total paid-in capital and R.E.
$92,000
Deduct: Treasury stock
1,000
Total stockholders’ equity
$91,000
© Copyright Doug Hillman 1999
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Quality of Income Information
Accounting methods and estimates used
to prepare financial statements
 Number and size of nonrecurring
revenue and expense items on income
statement

© Copyright Doug Hillman 1999
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Intraperiod Tax Allocation
Assigning the tax consequences of
nonrecurring items to the item
 Assume a nonrecurring loss of $40,000
with a tax rate of 30%
Loss
$40,000
Tax savings due to loss
12,000
Loss net of tax
$28,000

© Copyright Doug Hillman 1999
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Continuing Operations
Financial statement users want to know
income from continuing operations
 It is important number for predicting
future earnings

© Copyright Doug Hillman 1999
28
Nonrecurring Income Statement
Items
Discontinued operations
 Extraordinary items
 Cumulative effect of change in
accounting principle

© Copyright Doug Hillman 1999
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Discontinued Operations
A line of business or class of customer
may qualify as discontinued segment
 When management decides to dispose
of a segment, results for segment must
be reported separately

© Copyright Doug Hillman 1999
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Discontinued Operations
Two elements reported for discontinued
segment
› Operating income or loss for period
› Gain or loss on disposal of the
segment
 Each element reported net of tax

© Copyright Doug Hillman 1999
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Extraordinary Items
Gains and losses that are both unusual
and infrequent
 Must consider the environment in which
firm operates
 Reported net of tax

© Copyright Doug Hillman 1999
32
Examples of Extraordinary Items
Uninsured losses from earthquakes and
fires
 Gains or losses from early retirement of
debt
 Gains and losses from passing a new
law
 Gains and losses from foreign
governments taking business property

© Copyright Doug Hillman 1999
33
Changes in Accounting Principle
Consistency principle states should use
same accounting principles from period
to period
 Change permitted when it improves
reporting
 Reported net of tax

© Copyright Doug Hillman 1999
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Changes in Accounting Principle
Changes in principle often would have
changed prior periods’ expenses
 Total change in net income for prior
periods is cumulative effect of a change
in accounting principle

© Copyright Doug Hillman 1999
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Reporting Earnings Per Share
Income from continuing operations
 Discontinued operations
 Extraordinary items
 Cumulative effect of change in
accounting principle
 Net income

© Copyright Doug Hillman 1999
36
Earnings Per Share
Expresses net income on a percommon-share basis
 Under FASB Statement No. 128
presentation depends on whether simple
or complex capital structure
 Simple capital structure - no debt or
equity that could dilute EPS
 Complex capital structure - dilutive
securities

© Copyright Doug Hillman 1999
37
EPS - Weighted Average
Common Shares
For total year, sum of
› Number of shares outstanding times
fraction of year outstanding
 Used as denominator in EPS
calculations

© Copyright Doug Hillman 1999
38
EPS - Simple Capital Structure
Net income minus dividends on
preferred stock
 divided by
 Weighted average number of common
shares outstanding

© Copyright Doug Hillman 1999
39
Complex Capital Structure
Convertible debt or equity securities that
have potential to dilute (decrease) EPS
 Present two earnings per share figures
 Basic earnings per share
› EPS based on weighted average
common shares
 Diluted earnings per share
› Assumes all dilutive securities
converted

© Copyright Doug Hillman 1999
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EPS Example
Net income $48,000
 Stock

› 10% Convertible Preferred, $100 par, 1,000
shares issued and outstanding, convertible
into 7,000 common
› Common, $1 par,
–Issued and outstanding 1/1 to 4/1,
16,000 shares
–Issued and outstanding 4/1 to 12/31,
20,000 shares
© Copyright Doug Hillman 1999
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EPS Example
Weighted average common shares
outstanding computation
› 16,000 x 1/4 = 4,000
› 20,000 x 3/4 = 15,000
 Weighted average common shares
outstanding
› 19,000 shares

© Copyright Doug Hillman 1999
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Basic EPS Computation
Preferred dividends
› 1,000 x ($100 x 0.10) = $10,000
 Net income available to common
› $48,000 - $10,000 = $38,000
 Basic EPS
› $38,000 / 19,000 = $2.00 per share

© Copyright Doug Hillman 1999
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Diluted Earnings Per Share
Assume convertible preferred converted
into common at beginning of year
 Weighted average common shares
› 19,000 + 7,000 = 26,000
 Net income available to common
› $48,000 - $0 = $48,000
 Diluted EPS
› $48,000 / 26,000 = $1.85 per share

© Copyright Doug Hillman 1999
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Analyzing Information
Major differences in capital structure
between companies
 Number of shares issued and
outstanding
 Treasury stock
 Market value
 Dividend yield
 ROA
 EPS and P/E ratio

© Copyright Doug Hillman 1999
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