StIce | StIce |Skousen
Equity Financing
Chapter 13
Intermediate Accounting
16E
Prepared by: Sarita Sheth | Santa Monica College
COPYRIGHT © 2007
Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are
trademarks used herein under license.
Learning Objectives
1. Identify the rights associated with
ownership of common and referred stock.
2. Record the issuance of stock for cash, on
a subscription basis, and in exchange for
non-cash 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 warrants.
Learning Objectives
5. Compute the compensation expense
associated with the granting of employee
stock options.
6. Determine which equity-related items
should be reported in the balance sheet
as liabilities.
7. Distinguish between stock conversions
that require a reduction in retained
earnings and those that do not.
8. List the factors that impact the Retained
Earnings balance.
Learning Objectives
9. Properly record cash dividends, property
dividends, and stock splits.
10. Explain the background of unrealized
gains and losses recorded as part of
accumulated other comprehensive
income, and list the major types of equity
reserves found in foreign balance sheets.
11. Prepare a statement of changes in
stockholders’ equity.
Time Line of Issues:
Owner’s Equity
ISSUE
preferred
or
common
stock
PAY
cash
dividends
INCREASE
shares
outstanding
through stock
dividends and
stock splits
GRANT
options to
officers and
employees
Time Line of Issues:
Owners’ Equity
REPURCHASE
shares of stock
CONVERT
other
securities into
shares of
common stock
REPORT
performance to
current and
potential
investors
Nature and Classifications of
Paid-In Capital
• A corporation is a legal artificial entity
separate from its owners.
• Individuals contribute capital for
which the corporation issues
certificates making them stockholders.
• The board of directors are elected by
the stockholders and they are in
charge of overseeing the long run plan
for the organization.
Common Stock
•
•
Common Stock (CS)- when a corporation is
formed, the single class of stock typically
issued.
Owners of common stock have these basic
rights:
1. To vote in the election of directors and in the
determination of certain corporate policies.
2. Preemptive right- to maintain one’s
proportional inerest in the corporation through
purchase of additional common stock if and
when it is issued.
Par or Stated Value
• Par Value- historically was equal to
the market value of the shares at
issuance.
• Today, most stocks have a nominal
par value or no par value.
• Stated value- stocks with no-par that
for financial reporting purposes acts
like a par value.
Preferred Stock
•
Rights given up by preferred
stockholders (PS):
1. Voting- in most PS are not allowed to
vote for the board of directors.
2. Sharing in success- Cash dividends
received by PS are usually fixed in
amount. If the firm does extremely well,
their dividend amount is not adjusted.
Preferred Stock
•
Rights enjoyed by preferred
stockholders:
1. Cash dividend preference- PS are
entitled to receive their full cash
dividend before any cash dividends are
paid to CS.
2. Liquidation preference- In the even of
bankruptcy, PS are entitled to have
their investments repaid before CS.
Types of Preferred Stock
Has the right to receive
Cumulative
accumulated dividends before
any dividends may be paid to
common
stockholders.
Dividends on cumulative
preferred
stock that are
passed are referred to as dividends in arrears.
NonCumulative
Has no right to “passed”
dividends.
Participating
Has claim to a portion of
common dividends after
receiving preferred dividends.
Types of Preferred Stock
Convertible
Callable
Redeemable
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
• The issuance of stock for cash is
recorded by a debit to Cash and a
credit to Capital Stock for the par
value.
• When the amount of cash received for
the stock is more than the par value,
the excess is recorded as a credit to
additional paid-in capital or paid in
capital in excess of par.
Capital Stock Issued for Cash
Goode Corporation
issued 4,000 shares of
$1 par common stock
on April 1, 2006, for
$45,000 cash.
Apr. 1
Cash
45,000
Common Stock
Paid-In Capital in Excess of Par
4,000
41,000
Capital Stock Issued for Cash
Goode Corporation issued
4,000 shares of no par
common stock without a stated
value on April 1, 2006, for
$45,000 cash.
Apr. 1
Cash
Common Stock
45,000
45,000
Capital Stock sold on
Subscription
On November 1, 2006, 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
CS Subscription Receivable
62,500
Common Stock Subscribed
5,000
Paid-In Capital in Excess of Par
57,500
Nov. 1
Cash
31,250
Common Stock
Subscription Receivable
31,250
Capital Stock Sold on
Subscription
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
Dec. 9
Common Stock Subscribed
Common Stock
15,625
15,625
2,500
2,500
Capital 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
Capital 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
Reasons Companies
Repurchase Stock
1. Provide shares for incentive
compensation and employee savings
plans.
2. Obtain shares needed to satisfy
requests by holders of convertible
securities.
3. Reduce the amount of equity relative
to the amount of debt.
4. Invest excess cash temporarily.
Reasons Companies
Repurchase Stock (cont.)
5. Remove some shares from the open
market in order to protect against a
hostile takeover.
6. Improve per-share earnings by reducing
the number of shares outstanding and
returning inefficiently used assets to
shareholders.
7. 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.
Treasury Stock
Issued 10,000, $1 par value shares at $15 per share
Cost Method
Cash
Common Stock.
Paid-In Capital in
Excess of Par
150,000
10,000
140,000
Par Value Method
Cash
Common Stock.
Paid-In Capital in
Excess of Par
150,000
10,000
140,000
Treasury Stock
Required 1,000 shares at $40 per share.
Cost Method
Treasury Stock
Cash
40,000
40,000
Par Value Method
Treasury Stock
Paid-In Capital in Excess of Par
Retained Earnings
Cash
1,000
14,000
25,000
40,000
Treasury Stock
Retired remaining 300 shares of treasury stock.
Cost Method
Common Stock
300
Paid-in Capital in Excess of Par 4,200
Retained Earnings
7,500
Treasury Stock
12,000
Par Value Method
Common Stock
Treasury Stock
300
300
Stop and Think
After looking at this
comparison on page 791
in your book, why do
you think so few
companies use the pare
value method?
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.
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.
Stock Warrants
Value
Total
assigned to = issue
warrants
price
x
Market value of warrants
Market
Market
value of + value of
security
warrants
without
warrants
Value
$3
= $2,900
assigned = $58,000 x
$57 + $3
to
warrants
Stock Warrants
The entry on Stewart’s book to record
the sale of the preferred stock with
detachable warrants is:
Cash
58,000
Preferred Stock, $50 par
Paid-In Capital in Excess of
Par--Preferred Stock
Common Stock Warrants
50,000
5,100
2,900
Stock Warrants
If the warrants were exercised:
Common Stock Warrants
2,900
Cash
25,000
CS, $2 par
Paid-In Capital Excess of Par-CS
2,900
25,900
If the warrants were allowed to expire:
Common Stock Warrants 2,900
Paid-In Capital Excess of Par-CS
2,900
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.
3
3
Stock Based Compensation
The company estimates a grant date value of $10
for each of the employee stock options. The total
fair value of the options granted is $100,000.
Compensation cost is allocated over three years
from January 1, 2006 (the grant date) to January
1, 2009 (the vesting date).
Dec 31, 2006
Compensation Expense
33,333
Paid-In Capital from Stock Options
33,333
$100,000 ÷ 3
Similar entries would be made in 2007 and 2008.
Stock Based Compensation
On 12/31, 2009, all 10,000 of the options are
exercised to purchase Neff’s no-par common
stock.
Cash
500,000
Paid-In Capital from Stock Options 100,000
CS, no par
600,000
On 12/31, 2009, if the options had been allowed to
expired:
Paid-In Capital from Stock Options 600,000
Pain-In Capital from Expired Options
600,000
Stop and Think
Assume that Neff’s managers
are greedy, unscrupulous
scoundrels. Which one of
the following might Neff’s
performance based stock
options plan cause Neff’s
management (the ones who
are receiving the stock
options) to do?
Stock Conversions
Case 1
On December 31, 2008, 1,000 shares of preferred
stock (par $50) are exchanged for 4,000 shares of
common stock (par $1)
Dec 31, 2008
Preferred Stock, $50 par
50,000
Paid-In Capital in Excess of ParPreferred CS, $1
10,000
CS, $1 par
Paid-In Capital in
Excess of Par-Common
4,000
56,000
Stock Conversions
Case 2
On December 31, 2008, 1,000 shares of
preferred stock (par $50) are exchanged for
4,000 shares of common stock (par $20)
Dec 31, 2008
Preferred Stock, $50 par
Paid-In Capital in Excess of ParPreferred
Retained Earnings
CS, $1 par
50,000
10,000
20,000
4,000
Factors Affecting
Retained Earnings
•Error corrections
•Some changes in
accounting principle
•Net income
•Quasi-reorganizations
Retained
Earnings
Increases
Factors Affecting
Retained Earnings
Decreases
•Error
corrections
•Prior period
adjustments
•Treasury stock
•Net loss
•Some changes in
accounting
principles
•Cash and stock
Retained dividends
Earnings
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.
Cash Dividends
ABC Corporation declares a $100,000
dividend; the following journal entries
should be made:
Declaration Date
Dividends (Retained Earnings)
100,000
Dividends Payable
100,000
Payment Date
Dividends Payable
Cash
100,000
100,000
Property Dividends
• Property dividends- a distribution to
stockholders that is payable in some
asset other than cash.
Bigler Corporation owns 100,000 shares in
Tri-State Oil Co, carrying value $2,700,000,
current market value $3,000,000, or $30 per
share. There are 1,000,000 shares of Bigler
stock outstanding. A dividend of 1/10 of a
share of Tri-State Oil Co. is declared for each
share of Bigler stock outstanding.
Property Dividends
Declaration of Dividend
Dividend (or Retained Earnings) 3,000,000
Property Dividends Payable
2,700,000
Gain on Distribution of Property
Dividend
300,000
Payment of Dividend
Property Dividends Payable
2,700,000
Investment in Tri-State Oil Co.
2,700,000
Stock Dividends
• 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.
Stock Dividend: Example 1
Assume the following about Gean, Inc.:
•Common stock ($2 par, 10,000
shares outstanding)
$20,000
•Additional paid-in capital
$24,200
•Retained earnings
•Stock dividend declared
shares
$12,500
1,500
Because 1,500 shares represent 15% of the
Is
this a large
orofa
small
stock
dividend??
•Market
price
outstanding
stock,
itstock
is a small
stock
dividend.
Stock Dividend: Example 1
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
Common Stock
3,000
3,000
Stock Dividend: Example 2
Assume the following about Gimili, Inc.:
•Common stock ($5 par, 20,000
shares outstanding)
$100,000
•Additional paid-in capital
$100,000
•Retained earnings
•Stock dividend declared
shares
$52,000
10,000
50% =ofLarge
•Market price
stockDividend
Stock Dividend: Example 2
Declaration Date
Retained Earnings
50,000
Stock Dividends Distributable
50,000
Issuance Date
Stock Dividends Distributable 50,000
Common Stock
50,000
Stop and Think
You are hired as an
accounting consultant
by a company that is
considering issuing
either a 20% stock
dividend or a 25% stock
dividend. From an
accounting standpoint,
which would you
recommend?
Liquidating Dividends
• Liquidating dividend- a return to stockholders of
a portion of contributed capital.
Stubbs Corp declared and paid a cash dividend
($10 cash dividend) totaling $100,000 and a
partial liquidating dividend for $50,000.
Declaration Date
Dividends (Retained Earnings)
100,000
Paid in Capital in Excess of Par
50,000
Dividends Payable
150,000
Payment Date
Dividends Payable
150,000
Cash
150,000
Unrealized Gains and Losses for
Available-for-Sale Securities
KendellAvailable-for-Sale
had net income of
$1,350. were
Other
securities
items that
impacted net
are:
not purchased
withincome
the immediate
Unrealized
gain (loss)
on availableintention
to resell,
but are not
goingsecurities
to be held for the long-term.
for-sale
$100
(Increase) Decrease in minimum
pension liability
(60 )
Unrealized gain (loss) on derivative
instruments
(20 )
Foreign currency translation
adjustment, increase (decrease) in
stockholders’ equity
300
Unrealized Gains and Losses for
Available-for-Sale Securities
Net income
$1,350
Other comprehensive income:
Unrealized gain on available-forsale securities
60
Increase in minimum pension liability (36 )
Unrealized loss on derivative
instruments
(12 )
Foreign current transaction
adjustments
180
Comprehensive income
$1,542
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.