1 Equity Financing Learning Objectives 1. Identify the rights associated with ownership of common and preferred stock. 2. Record the issuance of stock for cash, on a subscription basis, and in exchange for noncash assets or for services. 3. Use both the cost and par value methods to account for stock repurchases. 4. Account for the issuance of stock rights and stock warrants. 2 Learning Objectives 5. Explain the difference between the intrinsic value and fair value methods, and use both in accounting for a fixed stock option plan. 6. Distinguish between stock conversions that require a reduction in retained earnings and those that do not. 7. List the factors that impact the retained earnings balance. 3 Learning Objectives 8. Properly record cash dividends, property dividends, small and large stock dividends, and stock splits. 9. Explain the background of unrealized gains and losses recorded as direct equity adjustments, and list the major types of equity reserves founds in foreign balance sheets. 10. Prepare a statement of changes in stockholders’ equity. 4 Learning Objectives EXPANDED MATERIAL 11. Eliminate a retained earnings deficit through a quasi-reorganization. 12. Use both the intrinsic value and fair value methods to account for performance-based stock option plans and plans calling for a cash settlement. 5 Components of Stockholders’ Equity Stockholders’ Equity Retained Earnings Contributed Capital Legal Capital Additional Paid-In Capital Other 6 Common Stock The owners of common stock of a corporation can be thought of as the true owners of the business. 7 Common Stock Unless restricted by terms of the articles of incorporation, the common stockholder has certain basic rights. 8 Common Stock The right to vote in the election of directors and in the determination of certain corporate polices such as the management compensation plan or major corporate acquisitions. The right to maintain one’s proportional interest in the corporation through purchase of additional common stock if and when it is issued. 9 Preferred Stock The title Preferred isn’t “preferred” stock is better; it’s somewhat different. misleading. 10 Preferred Stock The protection enjoyed by preferred stockholders is: • Preferred stockholders are entitled to receive their full cash dividend before any cash dividend can be issued to common stockholders. • If the company goes bankrupt, preferred stockholders are entitled to have their investment repaid in full, before common stockholders receive anything. 11 Preferred Stock Cumulative Has the right to receive accumulated dividends before any dividends may be paid to common stockholders. NonCumulative Has no right to “passed” dividends. Participating Has claim to a portion of common dividends after receiving preferred dividends. 12 Preferred Stock Convertible Callable Redeemable 13 Permits the holder to exchange preferred stock for common stock. Permits the issuing company to redeem the preferred stock. Permits the holder to redeem the stock--usually with some restrictions. Issuance of Capital Stock Goode Corporation issued 4,000 shares of $1 par common stock on April 1, 2002, for $45,000 cash. Apr. 1 Cash Common Stock Paid-In Capital in Excess of Par 45,000 4,000 41,000 14 Issuance of Capital Stock Goode Corporation issued 4,000 shares of no-par common stock with a stated value of $1 on April1, 2002, for $45,000 cash. Apr. 1 Cash Common Stock Paid-In Capital in Excess of Stated Value 45,000 4,000 41,000 15 Issuance of Capital Stock On April 1, Goode Corporation issued 4,000 shares of no-par common stock without a stated value on April1, 2002, for $45,000 cash. Apr. 1 Cash Common Stock 45,000 45,000 16 Capital Stock Sold on Subscription On November 1, 2002, a firm received subscriptions for 5,000 shares of $1 par common at $12.50 per share with 50% down, balance due in 60 days. Nov. 1 Cash 31,250 Common Stock Subscription Receivable 31,250 Common stock Subscribed 5,000 Paid-In Capital in Excess of Par 57,500 17 Capital Stock Sold on Subscription 18 On December 9, received balance due on one-half of subscribers and issued stock to fully paid subscribers, 2,500 shares. Dec. 9 Cash Common Stock Subscription Receivable Common stock Subscribed Common Stock 15,625 15,625 2,500 2,500 Stock Issued for Consideration Other Than Cash AC Company issues 200 shares of $0.50 par value common stock in return for land. The company’s stock is currently selling for $50 per share. Dec. 5 Land 10,000 Common Stock Paid-In Capital in Excess of Par 100 9,900 19 Stock Issued for Consideration Other Than Cash Assume that the land has a readily determinable market price of $12,000, but AC Company’s common stock has no established fair market value. Dec. 5 Land 12,000 Common Stock 100 Paid-In Capital in Excess of Par 11,900 20 21 Stock Repurchases To provide shares for incentive compensation and employee savings plans. To obtain sharesWhy needed to satisfy repurchase requests by holders of convertible shares? securities. To reduce the amount of equity relative to the amount of debt. To invest excess cash temporarily. 22 Stock Repurchases To remove some shares from the open market in order to protect against a hostile takeover. To improve per-share earnings by reducing the number of shares outstanding and returning inefficiently used assets to shareholders. To display confidence that the stock is currently undervalued by the market. Treasury Stock • Stock issued by a corporation but subsequently reacquired by the corporation and held for possible future reissuance or retirement. • Reported as a contra-equity account, not as an asset. • Does not create a gain or loss on reacquisition, reissuance, or retirement. • May decrease Retained Earnings, but cannot increase it. 23 Treasury Stock--Example: Both Accounting Methods Issued 100, $10 par value shares at $15 per share Cost Method Cash 1,500 Common Stock. 1,000 Paid-In Capital in Excess of Par 500 Par Value Method Cash Common Stock Paid-In Capital in Excess of Par 1,500 1,000 500 24 Treasury Stock--Example: Both Accounting Methods Reacquired ten shares at $16 per share. Cost Method Treasury Stock Cash 160 160 Par Value Method Treasury Stock Paid-In Capital in Excess of Par Retained Earnings Cash 100 50 10 160 25 Treasury Stock--Example: Both Accounting Methods Sold two shares of treasury stock at $20 per share. Cost Method Cash 40 Treasury Stock 32 Paid-In Capital from Treasury Stock Par Value Method Cash Treasury Stock Paid-In Capital in Excess of Par 8 40 20 20 26 Treasury Stock--Example: Both Accounting Methods Sold five shares of treasury stock at $14 per share. Cost Method Cash Paid-In Capital from Treasury Stock Retained Earnings Treasury Stock 70 8 2 80 Par Value Method Cash Treasury Stock Paid-In Capital in Excess of Par 70 50 20 27 Treasury Stock--Example: Both Accounting Methods Retired remaining three shares of stock. Cost Method Common Stock Paid-In Capital in Excess of Par Retained Earnings Treasury Stock 30 15 3 48 Par Value Method Common Stock Treasury Stock 30 30 28 Stock Rights, Warrants, and Options Stock rights--Issued to existing shareholders to permit them to maintain their proportionate ownership interests when new shares are to be issued. Stock warrants--Sold by the corporation for cash, generally in conjunction with the issuance of another security. Stock options--Granted to officers or employees, usually as part of a compensation plan. 29 Stock Warrants Stewart Co. sells 1,000 shares of $50 par preferred stock for $58 per share. Stewart Co. gives the purchaser detachable warrants enabling the holders to subscribe to 1,000 shares of $2 par common stock for $25 per share. Immediately following the issuance of the stock, the warrants are selling for $3, and the fair market value of a preferred share without the warrant attached is $57. 30 Stock Warrants Value Total assigned to = issue warrants price Market value of warrants x Market value Market of security + value of without warrants warrants Value $3 = $2,900 assigned to = $58,000 x $57 + $3 warrants 31 32 Stock Warrants The entry on Stewart’s book to record the sale of the preferred stock with detachable warrants is: Cash Preferred Stock, $50 par Paid-In Capital in Excess of Par--Preferred Stock Common Stock Warrants 58,000 50,000 5,100 2,900 33 Stock Warrants If the warrants are exercised, the entry to record the issuance of common stock is: Common Stock Warrants Cash Common Stock, $2 par Paid-In Capital in Excess of Par--Common Stock 2,900 25,000 2,000 25,900 Stock-Based Compensation No Yes All employees eligible? No Shares offered equally? Compensatory Plan No Grant and Measurement dates same? Reasonable exercise period? No Yes Exercise Prices » Market Price? Non-compensatory Plan Yes No Number of shares and Exercise Price known? No Yes Record shares issued when stock is purchased. Determine compensation expense; amortize over period employee is to provide service. Determine actual expense; amortize over remaining period employee is to provide service. Record shares issued when stock is purchased. Adjust for Unearned Compensation, if any. Estimate compensation expense; amortize over period employee is to provide service. 3 4 Factors Affecting Retained Earnings Error corrections Changes in accounting principle Net income Quasi-reorganizations Retained Earnings Increases 35 Factors Affecting Retained Earnings Decrease s Error corrections Prior period adjustments Treasury stock Net loss Retained Earnings Changes in accounting principles Dividends 36 Accounting for Dividends • Declaration date: The date the corporation’s board of directors formally declares a dividend will be paid. • Date of record: The date on which stockholders of record are identified as those who will receive a dividend. • Date of payment: The date when the dividend is actually distributed to stockholders. 37 Cash Dividend ABC Corporation declares a $2,000 dividend; the following journal entries should be made: Declaration Date Dividends (Retained Earnings) 2,000 Dividends Payable 2,000 Payment Date Dividends Payable 2,000 Cash 2,000 38 Property Dividend What is a property dividend? 39 Property Dividend It is a distribution to stockholders that is payable in some asset other than cash. 40 41 Property Dividend XYZ Corporation declares a dividend of 1,000 shares of Gondor, Inc. stock (cost $3,000; fair market value, $5,000). Date of Declaration Dividend (or Retained Earnings) Property Dividends Payable Gain on Distribution of Property Dividend 5,000 3,000 2,000 42 Property Dividend Date of Payment Property Dividends Payable Investment in Gordor, Inc. Stock 3,000 3,000 Entry on the Books of a 50% Shareholder Investment in Gordor, Inc. Stock Dividend Revenue 2,500 2,500 43 Stock Dividends: Small or Large? • Small – Less than 20-25% of the outstanding shares. – Debit Retained Earnings for the MARKET value of the shares. • Large – Greater than 20-25% of the shares outstanding. – Debit Retained Earnings for the PAR value of the shares. Example 1: Stock Dividend • Assume the following about Gean, Inc.: thispar, a large or small – Common stockIs($2 10,000 stock dividend? shares outstanding) $20,000 – Additional paid-in capital $24,200 – Retained earnings $12,500 – Stock dividend declared 1,500 shares – Market price of stock $10/share 44 Example 1: Stock Dividend Because 1,500 shares • Assume the following about Gean, Inc.: represent 15% of the – Common stock ($2 par, 10,000 outstanding stock, it is a small stock dividend. shares outstanding) $20,000 – Additional paid-in capital $24,200 – Retained earnings $12,500 – Stock dividend declared 1,500 shares – Market price of stock $10/share 45 Example 1: Stock Dividend Declaration Date Retained Earnings 15,000 Stock Dividends Distributable 3,000 Paid-In Capital in Excess of Par 12,000 Issuance Date Stock Dividends Distributable 3,000 Common Stock 3,000 46 Example 2: Stock Dividend • Assume the following about Gimli’s Corp.: – Common Stock ($5 par, 20,000 shares outstanding) $100,000 – Additional Paid-In Capital $100,000 – Retained Earnings $52,000 – Stock Dividend Declared 10,000 shares – Market Price of Stock $20/share Is this a large smalldividend stock dividend? 50% =orlarge 47 Example 2: Stock Dividend Declaration Date Retained Earnings 50,000 Stock Dividends Distributable 50,000 Issuance Date Stock Dividends Distributable 50,000 Common Stock 50,000 48 Liquidating Dividend A liquidating dividend is a distribution representing a return to stockholders of a portion of contributed capital. 49 Disclosures Related to the Equity Section Capital stock may be: Authorized but unissued. Subscribed for and held for issuance pending receipt of cash for the full amount of the subscription price. Outstanding in the hands of stockholders. Reacquired and held by the corporation for subsequent reissuance. Canceled by appropriate corporate action. 50 Quasi-Reorganization Where state law permits, a company may eliminate a deficit through a restatement of invested capital balances. This provides a fresh start for the company with a zero balance in Retained Earnings. 51 Quasi-Reorganization Balance Sheet for Anon., Inc. Before Quasi-Reorganization Current assets................................ Land, building, and equipment........ Accumulated depreciation............... Total assets................................…. Liabilities......................................... Common stock ($10 par, 100 shares) Retained earnings........................... Total liabilities and equity............ $ 250 1,500 (600) $ 1,150 $ 300 1,000 (150) $ 1,150 52 Quasi-Reorganization Quasi-Reorganization Plan for Anon., Inc. • Reduce land, building, and equipment to fair market value of $600. • Reduce par value of stock to $5; create $500 of “additional paid-in capital.” • Apply $450 deficit ($150 from Retained Earnings and $300 from fixed asset revaluation) against Paid-In Capital. 53 54 Quasi-Reorganization Journal Entries for Anon., Inc. Quasi-Reorganization Fixed Asset Revaluation Retained Earnings Accumulated Depreciation Land, Building, and Equipment 300 200 500 55 Quasi-Reorganization Revalue Common Stock Common Stock, $10 par 1,000 Common Stock, $5 par 500 Paid-In Capital from Stock Revaluation 500 Erase Deficit Paid-In Capital Retained Earnings 450 450 Quasi-Reorganization Balance Sheet After Quasi-Reorganization Current assets..................................... Land, building, and equipment............ Accumulated depreciation................... Total assets....................................... Liabilities.............................................. Common stock ($5 par, 100 shares)... Paid-in capital...................................... Total liabilities and equity.................. $ 250 1,000 (400) $ 850 $ 300 500 50 $ 850 56 57 The End