AND
TEXT AND CASES
11 TH EDITION
RICHARD G. SCHROEDER
MYRTLE W. CLARK
JACK M. CATHEY

 Equity is risk capital

No guaranteed return

No repayment of the investment
 The mix of debt and equity is called a company’s capital structure

 Proprietary
 Entity
 Fund
 Commander
 Enterprise
 Residual equity

 SFAC No. 6 = residual interest


Definition of equity rests on definition of assets and liabilities
Assets – liabilities
 Liabilities vs Equity

Liabilities require transfer of resources

Equity has no transfer requirement
 FASB ASC 480-10

Requires that certain obligations that could be satisfied by issuance of equity securities be classified as liabilities



1.
2.
3.
FASB financial instruments project
Concerns about how to classify financial instruments in financial statements:
Financial instruments that have characteristics of liabilities, but are reported as equity or between liabilities and equity
Financial instruments that have characteristics of equity, but are presented between liabilities and equity
Financial instruments that have characteristics of both liabilities and equity, but are classified either as liabilities or equity.



1.
2.
3.
SFAS No. 150 (FASB ASC 480).
limited its scope to three classes of freestanding financial instruments that embody obligations for the issuer:
Manditorily redeemable preferred stock unless the redemption is required to occur only upon liquidation or termination of the issuer,
Obligations to repurchase the issuer’s equity shares by transferring assets, and
Certain obligations to issue a variable number of shares.
The Board determined that financial instruments that fall into all three classes should be classified as liabilities

 Forms of business organization

Sole proprietorship

Partnership

Corporation
 Most companies are sole proprietorships but the largest amount of business activity is carried out by corporations

 Limited liability
 Continuity
 Investment liquidity
 Variety of ownership interests

Paid-In Capital
OTHER
COMPREHENSIVE
INCOME
Earned Capital

 Common stock vs preferred stock
 Features of preferred stock

Conversion

Call

Cumulative

Participating

Redemption
Paid-in Capital

Compensatory
Noncompensatory


When do you measure compensation in a compensatory plan?
APB Opinion No. 25




Many accountants believe that the provisions of APB
No. 25 result in understated financial statement values
 That is, the provisions of APB 25 seldom resulted in companies recording compensation expense when stock options were granted
Exposure draft
SFAS No 123 issued 1995

Encouraged recognition of estimated value of stock options as expense.


Recommended, but did not require fair value approach (Black-Scholes)
If APB Opinion No. 25 approach was used must show proforma net income and EPS effects

 Concern of deceptive accounting practices (e.g. Enron, Tyco and
WorldCom).

Stock options used to avoid paying taxes
 Requires companies to estimate compensation expense

Fair market value


Disclose estimated expense on Income Statement
Binomial lattice method
 Opposition to provisions

 Types
 Valuation
 The equity-liability question

 Accumulated net profits
 Have not been distributed as dividends
 May be divided into appropriated and unappropriated

 Stock dividends vs. stock splits
 Treasury stock
 Other comprehensive income
 Quasi reorganizations

Financial Analysis of Stockholders’ Equity

Return on common shareholders’ equity (ROCSE)

Reports on a company’s performance from the point of view of its common stockholders

Based on proprietary theory
 Borrowing costs are considered expenses rather than a return on investment
Net income available to common shareholders
Average common stockholders’ equity

Return on Common Stockholders’ Equity
69.9%
ROCSE
69.4%
70.0%
60.0%
50.0%
40.0%
30.0%
20.0%
10.0%
0.0%
8.0%
6.6%
2010 2011
Hershey Tootsie

Financial Analysis of Stockholders’ Equity
 Financial structure ratio (FSR)

Proportion of the company’s assets that are being financed by the stockholders
Average assets
Average common stockholders’ equity

5.00
4.00
3.00
2.00
1.00
0.00
Financial Structure Ratio
FSR
4.68
4.80
1.29
1.29
2010 2011
Hershey Tootsie


“Framework for the Preparation of
Financial Statements” indicated a preference for the proprietary theory.
 Also indicated that equity may be sub classified into:


Contributed capital
Retained earnings

Capital maintenance adjustments

 Specify financial reporting by entity for effects of share-based payment transactions
 Broader than concept of employee share options
 Measurement principles and specific requirements for 3 types of share-based payment transactions:
1.
Equity-settled share-based payment transactions
2.
3.
Cash-settled share-based payment transactions
Transactions involving receipt of goods or services

End of Chapter 15
Prepared by Kathryn Yarbrough, MBA
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