Chapter16
Contributed Capital
Intermediate Accounting 10th edition
Nikolai Bazley Jones
An electronic presentation
by Norman Sunderman
Angelo State University
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation.
Thomson, the Star logo, and South-Western are trademarks used herein under license.
2
Types of Corporations
Owned by governmental units
1. Private Corporations
(FDIC)
(stock and nonstock;
open and closed)
2. Public corporations
3. Domestic
corporations
4. Foreign corporations Incorporated in the state
Available for
purchase by
the public
universities,
hospitals,
churches
that it is operating in
Incorporated in
another state
3
Stockholders’ Rights
The right to share in the profits when a
dividend is declared.
The right to elect directors and to
establish corporate policies.
The right (called a preemptive right) to
maintain a proportionate interest.
The right to share in the distribution of
the assets of the corporation if it is
liquidated.
4
Advantages of the Corporate
Form
Limited liability
Capital accumulation
Ease of transferability
5
Disadvantages of the
Corporate Form
Increased taxation
Difficulties of control
Regulation
6
Basic Terminology
Outstanding
Authorized capital capital stock-The number of
stock--The
number of shares shares of capital
stock that a
of capital stock
that a corporation corporation has
issued to its
may issue as
stockholders
stated in its
and that are still
charter.
being held by
them on a
specific date.
Issued capital
stock--The
number of shares
of capital stock
that a corporation
has issued to its
stockholders as of
a specific date.
7
Basic Terminology
Outstanding
Issued capital
Authorized capital capital stock-The number of
stock--The
stock--The
Treasury stock-Subscribed
capital
number of shares shares of capital number of shares
The number of
stock--The
stock
that
a
of capital stock
of capital stock
shares of capital
number
of
shares
that a corporation corporation has that a corporation
stock that a
of
capital
stock
issued
to
its
has issued to its
may issue as
corporation has
that
a
corporation
stockholders stockholders as of
stated in its
issued to its
will
issue
using
an
and that are still a specific date.
charter.
stockholders and
installment being held
by
reacquired
purchase plan. them onhas
a
but not retired.
specific date.
8
Basic Terminology
Authorized
Capital Stock
Issued Capital Stock
* Outstanding capital
stock
* Treasury stock
Unissued Capital Stock
* Subscribed capital
stock
9
Legal Capital
Legal capital is the amount
of stockholders’ equity
that the corporation
cannot distribute to
stockholders.
10
Issuance of Capital Stock
When only one class of
stock is issued, it is
referred to as common
stock.
11
Issuance of Capital Stock
A corporation issues 500 shares of its
$10 par common stock for $18.
Cash
Common Stock, $10 par
Additional Paid-in Capital
on Common Stock
9,000
5,000
4,000
12
Issuance of Capital Stock
A corporation issues 500 shares of its
no-par stock common stock with a
stated value of $10 for $18 per share.
Cash
9,000
Common Stock, $10 stated value
Additional Paid-in Capital
on Common Stock
5,000
4,000
13
Issuance of Capital Stock
A corporation issues 500 shares of its
no-par, no-stated value common stock
for $18 per share.
Cash
9,000
Common Stock, no-par (500 shares)
9,000
14
Stock Issuance Costs
The FASB is planning to
change GAAP so that all
stock issuance costs are
expensed as incurred.
15
Stock Subscriptions
A corporation enters into a subscription contract
with several subscribers that calls for the
purchase of 1,000 shares of $6 par common stock
at a price of $13 per share. A $3 per share down
payment is required, with the remaining $10 due
in one month.
Cash
3,000
$6 x 1,000
Subscription Receivable: Common
Stock
10,000
Common Stock Subscribed
6,000
Additional Paid-in Capital on
Common Stock
7,000
16
Stock Subscriptions
The $10 per share final payment was received
from subscribers to 950 of the 1,000 shares.
Cash
Subscription Receivable:
Common Stock
9,500
Common Stock Subscribed
Common Stock, $6 par
5,700
9,500
5,700
950 x $6
17
Stock Subscriptions
When a default occurs, the accounting is
determined by the relevant contract provisions,
such as-1. Return to the subscriber the entire amount
paid in.
2. Return to the subscriber the entire amount
paid in, less any costs incurred to reissue the
stock.
3. Issue to the subscriber a lesser number of
shares based upon the total amount of payment
received.
4. Require the forfeiture of all amounts paid in.
18
Stock Subscriptions
The subscriber to the 50 remaining shares
defaults on the contract. The contract requires
the forfeiture of all amounts paid in.
Common Stock Subscribed
300
Additional Paid-in Capital on Common
Stock
350
Subscription Receivable:
50 X $10
Common Stock
Additional Paid-in Capital from
Subscription Default
50 X $6
50 X $7
500
150
19
Combined Sales of Stock
A corporation issues 100 packages of securities
for $82.80 per package. Each package consists of
two shares of $10 par common stock (market
value, $16 per share) and one share of $50 par
preferred stock (market value, $60 per share).
Common Stock: $16 x 2 shares x 100
Preferred Stock: $60 x 1 share x 100
Total market value
= $ 3,200
= 6,000
$9,200
20
Combined Sales of Stock
A corporation issues 100 packages of securities
for $82.80 per package. Each package consists of
two shares of $10 par common stock (market
value, $16 per share) and one share of $50 par
preferred stock (market value, $60 per share).
$3,200
Common Stock:
x $8,280
$9,200
$6,000
Preferred Stock:
x $8,280
$9,200
= $2,880
= 5,400
$8,280
21
Combined Sales of Stock
A corporation issues 100 packages of securities
for $82.80 per package. Each package consists of
two shares of $10 par common stock (market
value, $16 per share) and one share of $50 par
preferred stock (market value, $60 per share).
Cash
8,280
Common Stock
Additional Paid-in Capital on Com. Stock
Preferred Stock, $50 par
Additional Paid-in Capital on Pref. Stock
2,000
880
5,000
400
22
Stock Splits
A stock split results in a
decrease in the par value
per share of stock
accompanied by a
proportional increase in the
number of shares issued.
A stock split ordinarily is recorded
by a memorandum entry.
23
Noncompensatory Stock
Option Plans
An employee stock
purchase plan is
designed to raise capital
or obtain more
widespread ownership
of the corporate stock.
Three criteria must
be met for a share
option plan to
qualify as
noncompensatory.
24
Noncompensatory Stock
Option Plans
1. Substantially all
full-time
employees who
meet limited
employment
qualifications may
participate in the
plan on an
equitable basis.
2. The discount from the
market price does not exceed
the per-share amount of
stock issuance costs avoided
by not issuing the stock to
the public. A purchase
discount of 5% automatically
complies with this criterion.
25
Noncompensatory Stock
Option Plans
3. The plan has no option features other than the
following:
Employees are allowed a short time from the date
the purchase price is set to decide whether to
enroll in the plan (no longer than 31 days), and...
The purchase price is based solely on the market
price of the stock on the purchase date, and
employees are permitted to cancel their
participation before the purchase date and
receive a refund of any amounts previously paid.
26
Compensatory Stock
Option Plans
A share option plan that
does not possess ALL
three of the criterion for
a noncompensatory plan
is a compensatory plan.
27
Compensatory Stock
Option Plans
A corporation must use
the fair value method to
account for its
compensatory share
option plan.
28
Recognition of
Compensation Expense
On January 1, 2007, Fox Corporation adopts a
compensatory stock option plan and grants 9,000
stock options to 30 selected employees. The $50
exercise price is equal to the fair market price of
the stock on this grant date. Turnover is about
3%. Using an option pricing model in accordance
with FASB123R, Fox values each option at $17.15
on the grant date. Page 785
Continued
29
Fixed Stock Option Plan with
Cliff Vesting
Fox multiplies the fair value per stock option times
the estimated stock options that will become vested
[$17.15 x (9,000 x 0.97 x 0.97 x 0.97)] = $140,871.
Memorandum entry: On January 1, 2007, the company
granted a compensatory stock option plan to 30 employees.
The plan allows each employee to exercise 300 stock
options to acquire the same number of shares of the
company’s common stock at an exercise price of $50 per
share. The option vest at the end of 3 years and expire at
the end of 10 years. The estimated value of the stock
options expected to be exercised is $140,871. Page 785
Continued
30
Fixed Stock Option Plan with
Cliff Vesting
At the end of 2008, Fox changes the
estimated forfeiture rate to 6%.
At the end of 2009, a total of 7,500 stock
options for 25 employees actually vest and
the other 1,500 are forfeited.
31
Fixed Compensatory Stock
Option Plan
2007
2008
2009
Estimated (actual) total
compensation cost
$140,871 $128,201 128,625
Fraction of service period expired x 1/3
x 2/3
x 3/3
Est. compensation expense to date $46,957 $85,467 $128,625
Previously recognized com. exp.
(0) (46,957) (85,467)
Current compensation expense
$46,957 $38,510 $43,158
300 x (30 employees x 0.97 x
300 x 25 x $17.15
0.97 x 0.97) x $17.15
300 x (30 employees x 0.94 x
(fair value per option)
0.94 x 0.94) x $17.15
(fair value per option)
32
Fixed Compensatory Stock
Option Plan
On December 31, 2007, Fox Corporation records
the compensation expense by multiplying the
$140,871 by the fraction of the service period that
expired.
Compensation Expense
Common Stock Option Warrants
(Additional Paid-in-Capital)
46,957
46,957
$140,871 x 1/3
Continued
33
Fixed Compensatory Stock
Option Plan
Based on new estimations, at the end of 2008 Fox
Corporation revises total compensation cost to
$128,201 [$17.15 x (9,000 x 0.94 x 0.94 x 0.94)]. Twothirds of $128,201, or $85,467, has expired. Fox
previously recorded $46,957 in 2004, so a “catch-up”
entry is needed ($85,467 - $46,957 = $38,510).
Compensation Expense
Common Stock Option Warrants
Continued
38,510
38,510
34
Fixed Compensatory Stock
Option Plan
On January 5, 2010, one employee exercises
options to purchase 300 shares of Fox
Corporation’s $10 par common stock. On this
date the stock is selling for $70 per share. Fair
market value of warrants, $17.15.
Cash
15,000
Common Stock Option Warrants
5,145
Common Stock, $10 par
3,000
Additional Paid-in Capital on Common
Stock
17,145
300 x $17.15
35
Performance-Based Stock
Option Plan
A performance-based plan
is set up so that the terms
will vary depending on
how well the selected
employee performs.
In other words, the
better the employee
manages the
corporation, the
better the terms.
36
Performance-Based Stock
Option Plan
Assume the option plan depends on the increase in
market
share
of Fox’s
over
thethe
3-year
The
terms
for the
stockproducts
option plan
are
same
service
asof
follows
each
as
beforeperiod.
except The
Fox terms
grantsare
each
the 30for
selected
employee:
employees a maximum
of 300 stock options.
1. If the market share has increased 5 percent, at
least 100 stock options will vest on that date.
2. If the market share has increased by at least
10 percent, another 100 stock options will vest.
3. If the market share has increased by more
than 20%, all 300 stock options will vest.
37
Performance-Based Stock
Option Plans
On the grant date, Fox estimates that its market
share will increase between 10 and 20 %, so it
assumes that 200 options will vest per employee.
Based on new estimations, at the end of 2008 Fox
Corporation changes the employee forfeiture rate to
6%. At the end of 2009, 25 employees vest 7,500 stock
options.
Continued
38
Performance-Based Stock
Option Plan
2007
2008
2009
Estimated (actual) total
compensation cost
$93,914 $85,467 128,625
Fraction of service period expired x 1/3
x 2/3
x 3/3
Est. compensation expense to date $31,305 $56,978 $128,625
Previously recognized com. exp.
(0) (31,305) (56,978)
Current compensation expense
$31,305 $25,673 $ 71,647
200 x (30 employees x 0.97 x
0.97 x 0.97) x $17.15
(fair value per option)
300 x 25 x $17.15
200 x (30 employees x 0.94 x
0.94 x 0.94) x $17.15
(fair value per option)
39
Share Appreciation Rights
Although compensatory stock option plans provide
selected employees with the opportunity to acquire
shares of stock with a market value in excess of the
option price, these plans have some disadvantages.
At the time of the exercise, the employee must have
sufficient cash to pay the option price and any
income taxes.
In certain situations, this places a significant cash
flow burden on the employee. Share appreciation
rights enable the employee to receive cash, stock or a
combination of both for the excess of the market
value over a stated price .
40
Share Appreciation Rights
A company accounts for share appreciation rights
using the fair value method. Because the fair
value can only be determined on the exercise date,
the company must estimate the compensation cost
at the end of each year based on the fair value of
the SARs at that time.
Additional changes to expense are made each
year until the rights are exercised.
41
Share Appreciation Rights
Assume that on January 1, 2006, when the
market price is $60 per share, Wolf
Corporation grants 1,000 share
appreciation rights to one employee. The
employee will receive cash for the excess
between $60 and the quoted price on the
date of exercise. The service period is four
years and the rights must be exercised
within ten years. The SARs are valued at
$19 on the date of the grant.
42
Various Preferred Stock
Characteristics
 Preference as to dividends.
 Accumulation of dividends.
 Participation in excess dividends.
 Convertibility into common stock.
 Attachment of stock warrants (rights).
 Callability by the corporation.
 Redemption at a future maturity date.
 Preference as to assets upon liquidation of the
corporation. (no journal entry)
 Lack of voting rights.
43
Cumulative Preferred Stock
On cumulative preferred stock, if a
corporation fails to declare adequate
dividends at the usual date, the amount of
passed dividends becomes dividends in
arrears. These dividends accumulate and
dividends cannot be paid to common
shareholders until all preferred dividends in
arrears are paid.
44
Cumulative Preferred Stock
Dividends in arrears are not a
liability because they have not been
declared, but must be disclosed in
the footnotes to the financial
statements.
45
Cumulative Preferred Stock
Richland Corporation has outstanding 1,000 shares
of 10%, $100 par cumulative preferred stock. The
dividends are two years in arrears when a $30,000
dividend is declared. Preferred stockholders would
receive all of it.
1,000 shares x $100 x 0.10 x 3 years = $30,000
46
Cumulative Preferred Stock
Assume total dividends of $5,000, $11,000, $30,000
and $30,000 on the 10% cumulative preferred stock
with a par of $100,000.
Total Preferred Common
Year Dividends Dividends Dividends
Arrears
1
$5,000
$5,000
0
$5,000
2
$11,000
$11,000
0
$4,000
3
$30,000
$14,000
$16,000
0
4
$30,000
$10,000
$20,000
0
47
Convertible Preferred Stock
Convertible preferred stock
allows stockholders to convert
preferred stock into another
security, usually common
stock.
48
Convertible Preferred Stock
No value is assigned
to the convertible
feature.
Since corporations may not show a
gain or loss by trading in their own
stock, the book value method must
be used.
49
Convertible Preferred Stock
Ness Corporation originally issued 500 shares of
$100 par convertible preferred stock at $120 per
share. Each share of preferred stock may be
converted into four shares of $20 par common stock.
Preferred Stock, $100 par
50,000
Additional Paid-in Capital on Preferred
Stock
10,000
Common Stock, $20 par
40,000
Additional Paid-in Capital from
Preferred Stock Conversion
20,000
Continued
50
Convertible Preferred Stock
Alternatively, assume each preferred share may
be converted into seven shares of common stock.
Preferred Stock, $100 par
50,000
Additional Paid-in Capital on Preferred
Stock
10,000
Retained Earnings
10,000
Common Stock, $20 par
70,000
51
Preferred Stock with Stock
Warrants
A corporation may
attach warrants to
preferred stock to
enhance their
attractiveness.
These warrants
represent rights to
purchase additional
common shares at a
specified price in the
future.
52
Preferred Stock with Stock
Warrants
The corporation is
actually selling two
different securities,
preferred stock and
warrants.
Therefore, the proceeds
must be allocated to the
two securities based
upon their fair values.
53
Preferred Stock with Stock
Warrants (Rights)
Ponce Corporation issues 1,000 shares of $100 par
value preferred stock at a price of $121 per share. It
attaches a warrant to each share of stock that allows
the holder to purchase one share of $10 par common
stock at $40 per share. Immediately after the
issuance, the preferred stock begins selling ex rights
for $119 per share and the warrants for $6 each.
Preferred Stock:
$119,000
x $121,000 = $115,192
$119,000 + $6,000
Common Stock
$6,000
x $121,000 =
5,808
Warrants:
Continued
$119,000 + $6,000
54
Preferred Stock with Stock
Warrants (Rights)
When issued
Cash ($121 x 1,000)
121,000
Preferred Stock, $100 par
100,000
Additional Paid-in-Capital on
Preferred Stock
15,192
Common Stock Warrants (equity)
5,808
55
Preferred Stock with Stock
Warrants (Rights)
All warrants are exercised.
Cash ($40 x 1,000)
Common Stock Warrants
Common Stock, $10 par
Additional Paid-in Capital on
Common Stock
40,000
5,808
10,000
35,808
56
Callable Preferred Stock
Callable preferred stock
may be retired under
specified conditions by a
corporation at its option.
57
Callable Preferred Stock
Li Corporation has outstanding 1,000 shares of
$100 par callable preferred stock that were
issued at $110 per share and no dividends are in
arrears. The call price is $112 per share.
Preferred Stock, $100 par
Additional Paid-in Capital on
Preferred Stock
Retained Earnings
Cash
100,000
10,000
2,000
112,000
58
Callable Preferred Stock
Li Corporation has outstanding 1,000 shares of
$100 par callable preferred stock that were
issued at $110 per share and no dividends are in
arrears. The call price is $105 per share.
Preferred Stock, $100 par
100,000
Additional Paid-in Capital on Preferred
Stock
10,000
Cash
105,000
Additional Paid-in Capital from
Recall of Preferred Stock
5,000
59
Treasury Stock
Treasury stock is a
corporation’s own
capital stock that...
 has been fully paid for
by stockholders,
 has been legally
issued,
 is reacquired by the
corporation, and
 is being held by the
corporation for future
reissuance.
60
Reasons for Treasury Stock
To use for stock options, bonuses, and employee
purchase plans
To use for convertible bonds and preferred
stock
To use excess cash instead of paying dividends
To use in acquiring other companies
To reduce outstanding shares and increase EPS
To buy out hostile shareholders
To use for stock dividends
61
Treasury Stock
Cost Method
Ball issues 6,000 shares of $10 par common
stock for $12 per share:
Cash
72,000
Common Stock $10 par
60,000
Additional Paid-in Capital on
Common Stock
12,000
62
Treasury Stock
Cost Method
Reacquisition of 1,000 shares of common stock
at $13 per share:
Treasury Stock
Cash
13,000
13,000
63
Treasury Stock
Cost Method
Reissuance of 600 shares of treasury stock at
$15 per share:
Cash
9,000
Treasury Stock
7,800
Additional Paid-in Capital from
Treasury Stock
1,200
64
Treasury Stock
Cost Method
Reissuance of another 200 shares of treasury
stock at $8 per share:
Cash
1,600
Additional Paid-in Capital from
Treasury Stock
1,000
Treasury Stock
2,600
65
Treasury Stock
Cost Method
Reissuance of another 100 shares of treasury
stock at $10 per share:
Cash
1,000
Additional Paid-in Capital from
Treasury Stock
200
Retained Earnings
100
Treasury Stock
1,300
66
Treasury Stock
Par Value Method
Issuance of 6,000 shares of $10 par common
stock for $12 per share:
Cash
72,000
Common Stock $10 par
60,000
Additional Paid-in Capital on
Common Stock
12,000
67
Treasury Stock
Par Value Method
Reacquisition of 1,000 shares of common stock
at $13 per share:
Treasury Stock
10,000
Additional Paid-in Capital on
Common Stock
2,000
Retained Earnings
1,000
Cash
13,000
68
Treasury Stock
Par Value Method
Reissuance of 600 shares of treasury stock at
$15 per share:
Cash
9,000
Treasury Stock
6,000
Additional Paid-in Capital on
Common Stock
3,000
69
Treasury Stock
Par Value Method
Reissuance of another 200 shares of
treasury stock at $8 per share:
Cash
Additional Paid-in Capital on
Common Stock
Treasury Stock
1,600
400
2,000
70
Treasury Stock
Par Value Method
Reissuance of another 100 shares of treasury
stock at $10 per share:
Cash
Treasury Stock
1,000
1,000
71
Conceptual Overview of
Treasury Stock
Treasury stock is not an asset.
Treasury stock does not vote, has no
preemptive rights, ordinarily does not
share in dividends, or participate in the
company’s liquidation assets, but does
participate in stock splits.
3. Treasury stock transactions do not
result in gains or losses.
1.
2.
Continued
72
Conceptual Overview of
Treasury Stock
4. Treasury stock transactions may reduce
retained earnings, but may never
increase it.
5. Retained earnings usually must be
restricted regarding dividends when
treasury stock is held.
6. Total corporate stockholders’ equity is
not affected by whether cost or par value
method is used.
73
Retirement of Treasury Stock
Occasionally, a board of
directors may decide to
retire treasury stock and
reduce the legal capital
74
Retirement of Treasury Stock
Ball Corporation decides to retire the
remaining 100 shares of stock.
Cost Method
Common Stock, $10 par
1,000
Additional Paid-in-Capital($2 per share) 200
Retained Earnings (plug)
100
Treasury Stock
1,300
Par Value Method
Common Stock, $10 par
Treasury Stock
1,000
1,000
75
Chapter16
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