Chapter 11: Stockholders’ Equity
1.Debt versus equity
2.Preferred stock
3.Common stock
4.Accounting for preferred and common stock
5.Treasury stock
6.Retained Earnings and dividends
7. Statement of stockholders’ equity
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1. Debt versus Equity
Debt
Equity
Fixed maturity date
Fixed periodic payments
Security in case of default
No voice in management
Formal legal contract
Interest expense deductible
No fixed maturity date
Discretionary dividends
Residual asset interest
Voting rights - common
No legal contract
Dividends not deductible
Double taxation
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2. Preferred Stock

Advantages
–
–
–
–

Preference over common in liquidation
Stated dividend
Variety of features regarding dividends
Preference over common in dividend payout
Disadvantages
– Subordinate to debt in liquidation
– Stated dividend can be skipped
– No voting rights (versus common)

Debt or equity?
– components of both
– usually (but not always) classified with equity
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3. Common Stock

Advantages
– Voting rights:
election of board of directors
 vote on significant activities of
management
– Rights to residual profits (after preferred)


Disadvantages
– Last in liquidation
– No guaranteed return
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4. Accounting for Common Stock
(CS) and Preferred Stock (PS)

Par value - initially established to create a
“minimum legal capital”.
– Ex: Minimum legal capital in some states is
$1,000 for new corporations, so issue:



1,000 shares at $1par, or
100 shares at $10 par, or other combination. . .
Par value is not market value.
 Credit CS or PS for par value.
 Excess over par credited to “Paid in Capital in
Excess of Par or Stated Value” or abbreviated:
“Additional Paid-in Capital” (APIC).
 Some newer stock issues (for common stock) are
“no par” stock.
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4. Journal Entries
Issue PS at greater than par value:
Cash
xx
mkt. value
Preferred Stock
xx total par
APIC - PS
xx excess(plug)
Issue CS at greater than par value:
Cash
xx
mkt. value
Common Stock
xx total par
APIC - CS
xx excess(plug)
Note: most states do not allow companies
to issue at less than par value.
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4. Journal Entries -continued
Issue no par common stock:
Cash
xx
Common Stock
xx
mkt. value
mkt. value
Note: many companies have newer stock
issues that are no par, but most companies
still have older stock issues which contain a
par value and APIC.
The Stockholders’ Equity section of the balance
sheet of Sample Company (next slide)
illustrates many of the components of SE
discussed in this chapter.
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4.Sample Co. Stockholders’ Equity
Common stock, $1 par value, 500,000 shares
authorized, 80,000 shares issued, and
75,000 shares outstanding
$ 80,000
Preferred stock, $100 par value, 1,000 shares
authorized, 100 shares issued and
outstanding
10,000
Paid in capital on common
Paid in capital on preferred
25,000
$ 20,000
5,000
Retained earnings
22,000
Less: Treasury stock, 5,000 shares (at cost)
(6,000)
Total Stockholders’ Equity
$131,000
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4. Journal Entries-Sample Co.
Now, using Sample Company information,
record the following additional issues of
common and preferred stock:
Issued 100 shares of PS at $102 per share:
Issued 500 shares of CS at $5 per share:
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5. Treasury Stock

Created when a company buys back shares of
its own common stock.
 Reasons for buyback:
– reissue to employees for compensation.
– hold in treasury (or retire) to increase market
price and earnings per share.
– reduce total dividend payouts while
maintaining per share payouts.
– thwart takeover attempts by reducing
proportion of shares available for purchase.
– give cash back to existing shareholders.
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5. Treasury Stock - continued
The debit balance account called “Treasury
Stock” is reported in stockholders’ equity as a
contra (reduces SE). Note: not an asset.
 The stock remains issued, but is no longer
outstanding.
– does not have voting rights
– cannot receive cash dividends
 May be reissued (to the market or to employees)
or retired.
 No gains or losses are ever recognized from
these equity transactions.

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5. Treasury Stock(TS) - Journal Entries
There are two techniques for recording TS
transactions (Par Value method and Cost
method). We will use only the Cost method.
This technique establishes a “cost” for TS
equal to the amount paid to acquire the TS.
Par value is not used for TS transactions.
To record purchase of TS from market:
TS
xx
“cost”
Cash
xx market
(cost equals the cash paid)
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5. Treasury Stock(TS) - Journal Entries
To reissue TS to market at greater than cost:
Cash
xx
market
APIC - TS
xx over cost
TS
xx cost
To reissue TS to market at less than cost:
Cash
xx
market
APIC - TS
xx
if available
Retained Earnings xx
if needed*
TS
xx cost
*debit RE if no APIC-TS available to absorb the
remaining debit difference.
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5. TS - Example Problem
TT Corporation has 100,000 shares of $1 par value
stock authorized, issued and outstanding at
January 1, 2008. The stock had been issued at
an average market price of $5 per share, and
there have been no treasury stock transactions
to this point.
Assume that, in February of 2008, TT Corp.
repurchases 10,000 shares of its own stock at
$7 per share. In July of 2008, TT Corp. reissues
2,000 shares of the treasury stock for $8 per
share. In December of 2008, TT Corp. reissues
the remaining 8,000 shares for $6 per share.
Prepare the journal entries for 2008 regarding
the treasury stock.
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5. TS Example -Journal Entries
Feb: repurchase 10,000 sh. @ $7 =
$70,000.
July: reissue 2,000 sh @ $ 8 = $16,000
(cost = 2,000 @ $7 = 14,000)
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5. TS Example -Journal Entries
Dec: reissue 8,000 sh. @ $ 6 = $48,000
(cost = 8,000 sh.@ $7 = 56,000)
Now we need to debit one or more accounts to
compensate for the difference.
(1) debit APIC-TS (but lower limit is to -0-).
(2) debit RE if necessary for any remaining
balance (this is only necessary when we
are decreasing equity).
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6. Retained Earnings - Cash Dividends
As cash dividends are declared:
Dividends (RE) - common xx
Dividends (RE)- preferred xx
Dividends Payable
As cash dividends are paid:
Dividends Payable
xx
Cash
xx
xx
Preferred dividends may be issued with extra
privileges such as “cumulative” and “participating.
Cumulative preferred dividends that are skipped in a
particular year must be settled before any
dividends are paid to common shares.
Participating preferred stock may receive a cash
dividend in excess of its stated amount.
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7. Statement of Stockholders’ Equity
In this chapter, we have discussed the
Statement of Retained Earnings as the link
between the balance sheet and the income
statement.
 However, earlier chapters introduced the
Statement of Stockholders’ Equity, which
has become the default statement for large
companies in recent years.
 The Statement of Stockholders’ Equity
details the change in retained earnings,
including all the changes discussed in this
chapter, and it also shows the change
during the year in all of the stockholders’
equity accounts.

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