Chapter
11
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Chapter 11
Reporting and Analyzing
Stockholders’ Equity
After studying Chapter 11, you should
be able to:
Identify and discuss the major
characteristics of a corporation.
Record the issuance of common
stock.
Explain the accounting for purchase
of treasury stock.
Differentiate preferred stock from
common stock.
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Chapter 11
Reporting and Analyzing
Stockholders’ Equity
After studying Chapter 11, you should
be able to:
Prepare the entries for cash dividends
and understand the effect of stock
dividends and stock splits.
Identify the items that affect retained
earnings.
Prepare a comprehensive
stockholders' equity section.
Evaluate a corporation's dividend and
earnings performance from a
stockholder's perspective.
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Corporation
Possess legal entity
Created by law
Has most of the rights and privileges
of a person
Classified by purpose and ownership
Purpose - profit or nonprofit
Ownership - publicly or privately
held
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Characteristics of a Corporation
Separate legal existence
Limited liability of stockholders
Transferable ownership rights
Ability to acquire capital
Continuous life
Corporation management
Government regulations
Additional taxes
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Stock Certificate Shows...
name of the corporation
stockholder's name
class and special features of the
stock
the number of shares owned
the signatures of
duly authorized
corporate officials.
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Authorized Stock...
Maximum amount of stock a
corporation is allowed to sell as
authorized by corporate charter.
Outstanding Stock...
Number of shares of issued stock
that are being held by stockholders.
7
Corporations Can Issue Stock...
Directly to investors (typical in
privately held corporations).
Indirectly through an investment
banking firm (customary with
publicly held corporations).
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Par Value Stock...
 Is capital stock that has been
assigned an arbitrary value per
share in the corporate charter.
 Is usually low because some
states levy a tax on the
corporation based on par value.
 The legal capital per share that
must be retained in the business.
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No-Par Value Stock...
Capital stock that has not been
assigned a value per share in the
corporate charter.
Stated Value of No-Par Stock
Amount per share assigned by the
board of directors to no-par stock.
Par Value and Stated Value have NO
relationship to market value.
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Stockholders’ Equity Section of
a Corporation’s Balance Sheet...
Two Parts:
Paid-in (contributed) capital
Retained earnings (earned
capital).
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Paid-in Capital...
Amount paid to corporation by
stockholders for shares of
ownership.
Retained Earnings...
Earned capital held for future
use in the business.
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Accounting for
Common Stock Issues
The issue of common stock affects
only paid-in capital accounts.
When the issuance of common
stock for cash is recorded, the par
value of the shares is credited to
common stock.
The portion of the proceeds above
or below par value is recorded in an
additional paid-in capital account.
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Issuing Stock Above Par
If Hydro-Slide, Inc., issues an additional
1,000 shares of the $1 par value common
stock for cash at $5 per share, the entry is:
Cash
5,000
Common Stock
1,000
Paid-in Capital in
Excess of Par Value
4,000
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Hydro-Slide, Inc.
Balance Sheet (partial)
Stockholders' equity
Paid-in capital
Common stock, par value
Additional paid-in capital
Total paid-in capital
Retained earnings
Total stockholders' equity
$ 2,000
4,000
$ 6,000
27,000
$33,000
15
Mead, Inc.
Balance Sheet (partial)
Stockholders' equity
Paid-in capital
Common stock,$5par value,
100,000 shares issued and
outstanding
Retained Earnings
Total stockholders’ equity
$ 500,000
200,000
$ 700,000
BEFORE TREASURY STOCK TRANSACTION
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Treasury Stock...
Is a corporation's own stock
that has been issued
fully paid for
reacquired by the corporation
held in its treasury for future
use.
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Corporations Acquire
Treasury Stock to...
Reissue shares to officers and employees
under bonus and stock compensation plans.
Increase trading of company's stock in
securities market in hopes of enhancing
market value.
Have additional shares available for use in
acquisition of other companies.
Reduce number of shares outstanding
thereby increasing earnings per share.
Prevent a hostile takeover.
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Purchase of Treasury Stock
On February 1, 2004, Mead acquires
4,000 shares of its stock at $8 per
share.
Treasury Stock
Cash
32,000
32,000
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Treasury Stock
The Treasury Stock account would increase
by the cost of the shares purchased $32,000.
The original paid-in capital account,
Common Stock, would not be affected
because the number of issued shares does
not change.
Treasury stock is deducted from total paidin capital and retained earnings in the
stockholders' equity section of the balance
sheet.
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Mead, Inc.
Balance Sheet (partial)
Stockholders' equity
Paid-in capital
Common stock,$5par value,
100,000 shares issued and
96,000 outstanding
Retained Earnings
Total stockholders’ equity
Less: Treasury Stock
Total stockholders’ equity
$ 500,000
200,000
700,000
32,000
$ 668,000
AFTER TREASURY STOCK TRANSACTION
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Preferred Stock...
Capital stock that has contractual
preferences over common stock in
certain areas.
Dividends
Assets in the event of liquidation
Preferred stockholders do not
have voting rights.
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Preferred Stock
 Assume Corporation issues 10,000 shares of
$10 par value preferred stock for $12 cash per
share.
Cash
120,000
Preferred Stock
Paid-in Capital in Excess
of Par Value--Preferred Stock
100,000
20,000
(Preferred stock may have either a par value
or no-par value.)
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Dividend Preferences
Preferred stockholders have the right to
share in the distribution of corporate
income before common stockholders.
The first claim to dividends does not
guarantee dividends.
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Cumulative Dividend...
Is a feature of preferred stock
entitling the stockholder to receive
current and unpaid prior-year
dividends before common
stockholders receive any dividends.
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Dividends in Arrears...
 Are preferred dividends that were
scheduled but were not declared
during a given period.
Are not a liability. No liability exists
until a dividend is declared by board
of directors.
Must be disclosed in the notes to the
financial statements.
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Dividends in Arrears
Scientific-Leasing has 5,000 shares of 7%, $100
par value cumulative preferred stock
outstanding.
The annual dividend is $35,000 (5,000 x $7 per
share).
Dividends are 2 years in arrears
Dividends in arrears ($35,000 x 2 years)
Current-year dividends
Total preferred dividends
$ 70,000
35,000
$105,000
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Liquidation Preference
Is a feature that gives preferred
stockholders preference to
corporate assets in the event of
liquidation.
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Dividend...
Is a distribution by a corporation to its
stockholders on a pro rata basis.
Pro rata means that if you own 10% of
the common shares, you will receive
10% of the dividend.
Dividend forms:
cash
stock
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Cash Dividend
Is a pro rata distribution of cash
to stockholders.
A corporation must have 2 things
to pay cash dividends:
Retained earnings
Adequate cash
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Cash Dividend
In many states, payment of dividends
from legal capital is illegal.
Payment of dividends from paid-in
capital in excess of par is legal in
some states.
Payment of dividends from retained
earnings is legal in all states.
Companies are frequently constrained
by agreements with lenders to pay
dividends only from retained earnings.
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Entries for Cash Dividends
Three dates are important in
connection with dividends:
 the declaration date
 the record date
 the payment date
Mo n th a n d ye a r
00
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Monda y
Tue sd a y
We dne sd a y
Thu rs da y
Frid a y
S a turda y
S un da y
00
The Declaration Date...
Is the date the board of directors declares
the cash dividend.
Commits the corporation to a binding legal
obligation that cannot be rescinded.
On December 1, 2004, the directors of Media
General declare a $.50 per share cash dividend on
100,000 shares of $10 par value common stock.
The dividend is $50,000 (100,000 x $.50).
12/1
Retained Earnings
Dividends Payable
50,000
50,000
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The Record Date...
The date ownership of the outstanding
shares is determined for dividend purposes.
Dec 20
No Entry Necessary.
The Payment Date...
The date dividend checks are mailed.
January 20 is the payment date for Media
General.
Jan 20 Dividends Payable
Cash
50,000
50,000
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A Stock Dividend...
Is a pro rata distribution of the
corporation's own stock to stockholders.
Is paid in stock.
Results in a decrease in retained earnings
and an increase in paid-in capital.
Does not decrease total stockholders'
equity or total assets.
Is often issued by companies that do not
have adequate cash to issue a cash
dividend.
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Stock Dividends
You have a 2% ownership interest in
Cetus Inc., owning 20 of its 1,000 shares
of common stock.
In a 10% stock dividend, 100 shares
(1,000 x 10%) of stock would be issued.
You would receive two shares (2% x 100),
but your ownership interest would remain
at 2% (22 /1,100).
You now own more shares of stock, but
your ownership interest has not changed.
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Reasons for Stock Dividends
To satisfy stockholders' dividend
expectations without spending cash.
To increase marketability of its stock by
increasing number of shares outstanding
and decreasing market price per share.
To emphasize that a portion of
stockholders' equity has been
permanently reinvested in business and
is unavailable for cash dividends.
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Stock Dividends
A small stock dividend (less than
20%-25% of the corporation's issued
stock) is recorded at the fair market
value per share.
A large stock dividend (greater than
20%-25% of the corporation's issued
stock) is recorded at par or stated
value per share.
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Stock Dividends
Medland Corporation has $300,000 in
retained earnings and declares a 10% stock
dividend on its 50,000 shares of $10 par
value common stock.
The current fair market value of the stock
is $15 per share.
Retained Earnings
75,000
Common Stock Dividends
50,000
Distributable
Paid-in Capital in Excess
25,000
of Par Value
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Stock Split...
Is the issuance of additional shares of
stock to stockholders accompanied by:
A reduction in the par or stated value.
An increase in number of shares.
A stock split does not have any effect on
total paid-in capital, retained earnings, and
total stockholders' equity.
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Stock Split
Because a stock split does not
affect the balances in
stockholders' equity accounts, it
is not necessary to journalize a
stock split.
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Retained Earnings...
Is net income that is retained in
the business.
The balance in retained earnings
is part of the stockholders' claim
on the total assets of the
corporation.
Retained earnings does not
represent a claim on any specific
asset.
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Deficit...
Is a debit balance in retained
earnings and is reported as a
deduction in the stockholders'
equity section of the balance
sheet.
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Retained Earnings Restrictions...
Are legal, contractual or
voluntary circumstances that
make a portion of retained
earnings currently unavailable for
dividends.
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AMAZON.COM
Balance Sheet (Partial)
December 31, 2000
(in thousands)
Stockholders Equity With Deficit
Stockholders' equity
Paid-in capital
Common Stock
$
3,571
Paid-in capital in excess of par value 1,322,479
Total paid-in capital
1,326,050
Accumulated Deficit
2,293,301
Total stockholders’ equity (deficit)
$ (967,251)
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Kmart, Inc.
Balance Sheet (Partial)
(in millions)
Stockholders Equity Section
Stockholders' equity
Common stock, $.01 par value;
1,500,000,000 shares authorized -250,000,000; 503,294,515
shares issued
$
503
Capital in excess of par value
1,695
Retained earnings
1,261
Total stockholders' equity
$ 3,459
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SARA LEE CORPORATION
Statement of Cash Flows (partial)
For the Year Ended June 30,2001
(in millions)
Cash flow from Financing Activities
Issuance of common stock
$
Purchase of common stock
Payment of dividends
Borrowing of long-term debt
Repayment of long-term debt
Short-term (repayments)borrowing
Net cash used in financing activities
104
(643)
(486)
1,023
(390)
(1,914)
(2,306)
The Payout Ratio =
CASH DIVIDENDS DECLARED ON COMMON STOCK
NET INCOME
… measures the percentage of earnings
distributed in the form of cash
dividends to common stockholders.
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Return on Equity Ratio =
NET INCOME - PREFERRED STOCK DIVIDENDS
AVERAGE COMMON STOCKHOLDERS’ EQUITY
...measures the profitability from
the stockholders’ point of view.
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Advantages of Bond Financing
Over Common Stock
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The Dividend Yield =
DIVIDENDS DECLARED PER SHARE OF COMMON STOCK
STOCK PRICE AT END OF YEAR
…reports the rate of return an
investor earned from dividends.
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Earnings Per Share =
NET INCOME - PREFERRED STOCK DIVIDENDS
AVERAGE COMMON SHARES OUTSTANDING
...measures the net income earned on
each share of common stock.
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Price-Earnings Ratio =
MARKET PRICE PER SHARE OF STOCK
EARNINGS PER SHARE
In order to make a meaningful
comparison of earnings across firms,
use the price-earnings ratio.
The price-earnings ratio reflects the
market’s assessment of a company's
future earnings.
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