Stockholders' Equity

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Introduction to Financial
Accounting Information, 7/e
11
Stockholders’
Equity
Statements and
the Annual
PowerPoint Author: Catherine Lumbattis Report
COPYRIGHT © 2011 South-Western/Cengage Learning
Advantages of
Stock vs. Debt Financing
 Flexibility
 Exchanges
facilitates trading
 Return on
investment
LO1
Disadvantages of
Stock vs. Debt Financing
 Control
 Tax consequences
 Impact on ratios
Expanded Accounting Equation
Assets = Liabilities + Owners’ Equity
Assets = Liabilities + Stockholders’ Equity
Contributed
Capital
Retained
Earnings
Retained Earnings Connects the
Income Statement and Balance Sheet
Income Statement
Revenues
Less: Expenses
Net Income
$
xxx
xxx
$ Net Inc
Statement of Retained Earnings
Retained Earnings, Beginning Balance
Add: Net Income
Deduct: Dividends
Retained Earnings, Ending Balance
$
xxx
inc
xxx
$ end
Balance Sheet
Total Assets
Total Liabilities
Stockholders’ Equity
Retained Earnings
Total Liabilities and Stockholders' Equity
$ xxx
$ xxx
xxx
end
$ xxx
Contributed Capital
 Common Stock
• Basic stock of corporation
• Normally carries voting rights
 Preferred Stock
• Optional
• Tailored to meet specific needs
Par Value
 “Legal capital”
 Arbitrary amount stated on
stock certificate
 Also called “stated value”
Additional Paid-in Capital
 Amount received in excess of par
when stock was originally issued
Retained Earnings
 Net income retained in the
business (not paid out as
dividends) since its inception
 Reinvested in a variety of assets
(not necessarily liquid or cash)
IFRS and Stockholders’ Equity
 International standards differ from U.S.
standards for those items that have
attributes of both debt and equity
 Convertible stock must be separated
into a part that is presented in the
Liability section and another part that is
presented as Stockholders’ Equity
section of the Balance Sheet
Preferred Stock
 Can tailor to specific needs of firm
 Stated dividend rate
• Percentage of the stock’s par
value
• Per-share amount
 Often carries dividend preference
over common stock
LO2
Stock Issued for Cash
Example:
1,000 shares of
$10 par value
stock
sold for $15 per
share
Common Stock $ 10,000
( $10 par value × 1,000 shares)
Additional Paid-In Capital $5,000
(($15 – $10) × 1,000 shares)
LO3
Recording Issuance of Stock
Stock Issued for Noncash
Consideration
 Record at fair market value of consideration
given or received, whichever is more readily
determinable
Building
Common or
Preferred
Stock
Treasury Stock
 Company buys back its own stock
 Contra-equity account (debit
balance)
 Not outstanding (no voting rights)
LO4
Presentation of Treasury Stock
Common stock, $10 par value, 1,000
shares issued, 900 outstanding
$10,000
Additional paid-in capital—Common 12,000
Retained earnings
15,000
Total contributed capital and
retained earnings
37,000
Less: Treasury stock, 100 shares
at cost ($25 per share)
2,500
Total stockholders’ equity
$34,500
Retirement of Stock
 Repurchase of stock and is not
intended to be resold
 A proportional amount of the
related Stock and Paid-In Capital
accounts must be eliminated
Cash Dividends
Date of Paid
declaration to
Stockholders
on date of record
on
Payment
date
LO 5
Dividend Requirements
 Sufficient cash
 Positive retained earnings
Dividend Payout Ratio
Annual Dividend Amount
Annual Net Income
The % of
earnings paid
as dividends
Dividends
Journal entry required to record:
(1) dividends declared
(2) dividends paid
12/31/10
Reduce
retained
earnings
1/15/11
Pay
dividends
Recording Cash Dividends
Declare a dividend:
Balance Sheet
Assets = Liabilities + Stockholders’
Equity
Dividends Retained
Payable Earnings
Payment of Dividend:
Cash Dividend
Payable
Income Statement
Revenues – Expenses = Net
Income
Allocation of Common and
Preferred Cash Dividends
1. Distribute dividends in arrears, if any, to
preferred
2. Distribute current year’s dividends to
preferred
3. Distribute remainder to common (or to
both if preferred is participating)
Stock Dividends
 Issue of additional shares
proportionately to existing stockholders
 Reasons:
• Insufficient cash
• Market price reduction
• Nontaxable to recipients
LO6
Small Stock Dividend Example
Stockholders’ Equity:
Common stock, $10 par, 5,000 shares
issued and outstanding
Additional paid-in capital—Common
Retained earnings
Total stockholders’ equity
Before Dividend
$ 50,000
30,000
70,000
$150,000
Assume Shah Company declares a 10% stock dividend;
500 shares @ $40 per share market value
Small Stock Dividend Example
Before
Stockholders’ Equity:
Common stock, $10 par, 5,500 shares $ 50,000
Additional paid-in capital—Common
30,000
Retained earnings
70,000
Total stockholders’ equity
$150,000
After
$ 55,000
45,000
50,000
$150,000
$40 market value deducted from retained earnings;
allocated between Common Stock (initially Common
Stock Dividend Distributable) and Additional
Paid-In Capital.
+
+
–
Large Stock Dividend Example
Before Dividend
Stockholders’ Equity:
Common stock, $10 par, 5,000 shares
issued and outstanding
$ 50,000
Additional paid-in capital—Common
30,000
Retained earnings
70,000
Total stockholders’ equity
$150,000
Assume Shah Company declares 100% stock dividend
Large Stock Dividend Example
Before
Stockholders’ Equity:
Common stock, $10 par, 10,000 shares $ 50,000
Additional paid-in capital—Common
30,000
Retained earnings
70,000
Total stockholders’ equity
$150,000
After
$100,000
30,000
20,000
$150,000
Dividend deducted from retained earnings and
recorded in the Common Stock account at par.
Additional Paid-In Capital account is unaffected.
+
–
Stock Splits
 Results in additional issuance of
shares
 Reduces par value per share
 No change in Stockholders’ Equity
accounts
LO 7
Stock Splits
 Not recorded in accounts
 Reduce market price per share and
make the stock more accessible to a
wider range of investors
 Disclosed in notes
2-for-1 Stock Split Example
Stockholders’ Equity:
Common stock, $10 par, 5,000 shares
issued and outstanding
Additional paid-in capital—Common
Retained earnings
Total stockholders’ equity
Before Split
$ 50,000
30,000
70,000
$150,000
Assume Shah Company declares 2-for-1 stock split
2-for-1 Stock Split Example
Before
Stockholders’ Equity:
Common stock, $5 par, 10,000 shares $ 50,000
Additional paid-in capital—Common
30,000
Retained earnings
70,000
Total stockholders’ equity
$150,000
Only disclosures
are affected
After
$ 50,000
30,000
70,000
$150,000
All accounts are unchanged
Statement of Stockholders’ Equity
 Explains all the reasons for the difference
between the beginning and the ending balance
of each of the accounts in the Stockholders’
Equity category of the balance sheet
Statement of Retained Earnings
Beginning retained earnings
Add: Net earnings
Subtract: Dividend(s) declared
= Ending retained earnings
LO8
Statement of
Comprehensive Income
Income Statement
For Year Ended December 31, 20XX
Revenues
xxx
Expenses
xxx
Other gains and losses
xxx
Income before tax
xxx
Income tax expense
xxx
Net income
xxx
Statement of Comprehensive Income
For Year Ended December 31, 20XX
Net income
xxx
Foreign currency translation
adjustment
xxx
Unrealized holding gains/losses
xxx
Minimum pension liability
adjustment
xxx
Other comprehensive income
xxx
Comprehensive income
xxx
Comprehensive income – the total change in net assets from all
sources except investments by or distributions to the owners
Analyzing Owners’ Equity
 Book value per share
• Rights that each share of common
stock has to the net assets of
corporation
 Market value per share
• Price at which stock is currently
selling
LO9
Book Value per Share
Total Stockholders’ Equity
Number of Shares of Stock Outstanding
 Amount per share of net assets to which
the company’s common stockholders have
the rights
 Does not indicate the price that should be
paid by those who want to buy or sell the
stock on the stock exchange
Market Value per Share
 The selling price of the stock as indicated
by the most recent transactions
 Usually stated in a 52-week high and low
 More meaningful measure of the value of
the stock than book value
52-week
High
Low
Daily
Sym
High
Low
Last
Change
68.17 39.17 GM
43.3
42.01 42.93 +0.48 (1.13%)
Stockholders’ Equity Items on
the Statement of Cash Flows
Operating Activities
Net income
Investing Activities
Financing Activities
Issuance of stock
Retirement or repurchase of stock
Payment of dividends
xxx
+
–
–
LO10
Appendix
Accounting Tools:
Unincorporated Businesses
Sole Proprietorships
 Not a separate legal entity so owner has
unlimited liability
 Must keep personal and business records
separate
 Business income is declared on the owner’s
personal tax return and taxed at personal tax
rate
LO11
Sole Proprietorship
Owner withdraws an auto from business:
Owners’ drawing or withdrawal accounts
are contra-equity accounts
Sole Proprietorships
 Drawing or withdrawal and income summary
accounts are closed to the owner’s capital
account
 Owner’s Equity section of the balance sheet
consists of the capital account:
Beginning balance
Plus: Investments
Net Income
Less: Withdrawals
Ending balance
$
0
10,000
4,000
(6,000)
$ 8,000
Partnerships
 Unlimited liability
 Limited life – partnership
agreements can and do end
 Not taxed as a separate entity
Partnerships
Distribution of income:
 Equal distribution
 Stated ratio
 Other allocation
• For example, based on salaries, interest on
invested capital, and a stated ratio
End of Chapter 11
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