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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.
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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.
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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.
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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.
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Components of
Stockholders’ Equity
Stockholders’
Equity
Retained
Earnings
Contributed
Capital
Legal
Capital
Additional
Paid-In
Capital
Other
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Common Stock
The owners of common
stock of a corporation can be
thought of as the true
owners of the business.
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Common Stock
Unless restricted by terms
of the articles of
incorporation, the common
stockholder has certain
basic rights.
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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.
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Preferred Stock
The title
Preferred isn’t
“preferred” stock is
better; it’s
somewhat
different.
misleading.
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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.
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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.
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Preferred Stock
Convertible
Callable
Redeemable
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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
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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
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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
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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
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Capital Stock Sold on
Subscription
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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
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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
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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.
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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.
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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
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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
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Treasury Stock--Example:
Both Accounting Methods
Sold two shares of treasury stock at $20 per share.
Cost Method
Cash
40
Treasury Stock
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Paid-In Capital
from Treasury
Stock
Par Value Method
Cash
Treasury Stock
Paid-In Capital in
Excess of Par
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40
20
20
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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
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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
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Par Value Method
Common Stock
Treasury Stock
30
30
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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.
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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.
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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
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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
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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.
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Factors Affecting
Retained Earnings
Error corrections
Changes in accounting
principle
Net income
Quasi-reorganizations
Retained
Earnings
Increases
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Factors Affecting
Retained Earnings
Decrease
s
Error corrections
Prior period
adjustments
Treasury stock
Net loss
Retained
Earnings
Changes in accounting
principles
Dividends
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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.
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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
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Property Dividend
What is a property
dividend?
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Property Dividend
It is a distribution to
stockholders that is
payable in some asset
other than cash.
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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
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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
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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
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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
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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
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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
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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
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Liquidating Dividend
A liquidating dividend is a
distribution representing a return
to stockholders of a portion of
contributed capital.
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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.
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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.
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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
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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.
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Quasi-Reorganization
Journal Entries for Anon., Inc.
Quasi-Reorganization
Fixed Asset Revaluation
Retained Earnings
Accumulated Depreciation
Land, Building, and Equipment
300
200
500
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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
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The End