Chapter 9 PowerPoints on Stockholders' Equity

Stockholders’ EquityChapter 9

9-1

Learning Objective 1

Explain the Features of a Corporation

9-2

Characteristics of a Corporation

9-3

Separate Legal Entity Corporation distinct from owners; artificial person

Continuous Life/Transfer of Ownership: Company continues

to exist & operate regardless of ownership changes

Separation of Ownership & Management: Stockholders

elect Board of Directors who, in turn, appoint officers

Limited LiabilityStockholders are not personally

liable for corporate debts

Corporate TaxationCorporations are taxed on their earnings; dividends distributed

to owners are also taxed

Government RegulationCorporate activities are

monitored by governmentregulations

Organizing a Corporation

Incorporators Organize the corporation Pay fees Sign charter File documents with the state Agree to bylaws

9-4

Authority Structure in a Corporation

9-5

Stockholders’ Rights

Vote at stockholder meetings

Receive dividends

Receive share if corporation liquidates

Maintain proportionate ownership Preemptive right

9-6

Parts of Stockholders’ Equity

Paid-in capital Represents amounts contributed by

stockholders Include stock accounts

Retained earnings Amounts earned and kept by the

corporation

9-7

Classes of Stock

Common Basic form of

common stock Have rights of

ownership Benefit most of

company succeeds Risk most if

company does not succeed

Preferred Have preference in

receiving dividends and assets in case of liquidation

Hybrid between common stock and debt

Rare for corporations to issue 9-8

Comparison of Issuing Stock and Debt

Common stock

Preferred stock

Long-term debt

Obligation to repay principal

No No Yes

Dividends/interest Dividends are not tax deductible

Dividends are not tax deductible

Interest expense is tax deductible

Obligation to pay dividends/interest

Only after declaration

Only after declaration

At fixed rates and date

9-9

Classes of Stock - Terminology

Par value Arbitrary amount

assigned to share of stock

In most states, represents minimum price for shares Legal capital

No-par Does not have a

par value

May have a stated value

9-10

Other Stock Terminology

Authorized

Issued

Outstanding

Issue price

Market price9-11

This slide is not in PowerPoint slides from Vista8

Learning Objective 2

Account for the Issuance of Stock

9-12

Issuing Common Stock at Par A company issues 100,000 shares of $5

par value common stock at par

The common stock account is always credited in the amount of the shares issued multiplied by par value

9-13

Date Accounts Debit Credit

  Cash$500,0

00  

  Common stock  $500,0

00

100,000 x $5

Issuing Common Stock Above Par

A company issues 100,000 shares of $5 par value stock for $12 per share

The amount above par is credited to Paid-in Capital in Excess of Par

9-14

Date Accounts Debit Credit

  Cash$1,200,00

0  

  Common stock  $500,00

0

  Paid-in capital in excess of par  

$700,000

(100,000 x $5 par)

(100,000 x $12 price)

$1,200,000 - $500,000

Issuing No Par Common Stock

A company issues 100,000 shares of no par value common stock at a price of $5 per share

Substitute market price for par value in journal entry

9-15

Date Accounts Debit Credit

  Cash$500,0

00  

  Common stock  $500,0

00

This slide is not in PowerPoint slides from Vista8

100,000 x $5

Issuing Common Stock for Noncash Assets

Assets recorded at their fair values Common stock and paid-in capital credited

accordingly Suppose a company purchased equipment

valued at $800,000 by issuing 50,000 shares of its $5 par common stock

9-16

Date Accounts Debit Credit

  Equipment $800,00

0  

  Common stock$250,00

0

  Paid-in capital in excess of par  

$550,000

(50,000 x $5 par)

(Fair value of equipment)

50,000 x $5

$800,000 - $250,000

S 9-7, p. 571

9-17

Journalize all transactions. Compare balances in all accounts in both cases. Same or different?

S 9-7, p. 571

Case A — Issue stock and buy the assets in separate transactions:

9-18

DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT

Cash 800,000

Common Stock (12,000 × $20)

240,000

Paid-in Capital in Excess of Par

560,000

Issued stock

Building 550,000

Equipment 250,000

Cash 800,000

Purchased plant assets

S 9-7 (continued)

Case B — Issue stock to acquire the assets:

9-19

DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT

Building 550,000

Equipment 250,000

Common Stock (12,000 × $20)

240,000

Paid-in Capital in Excess of Par

560,000

Issued stock to acquire building and equipment

S 9-7 (continued)

The balances in all accounts are the same:

9-20

Building…………………………………… $550,000

Equipment……………………………….… 250,000

Common Stock (12,000 × $20)……… 240,000

Paid-in Capital in Excess of Par……… 560,000

Preferred Stock

Follows the same pattern as common stock entries Preferred stock is credited for the shares

issued multiplied by the par value A separate paid-in capital account is

used if stock is issued above par

9-21

Authorized, Issued, and Outstanding

Authorized – maximum number of shares company can issue as indicated in its charter

Issued – number of shares company has sold to shareholders

Outstanding – number of shares currently in shareholders’ possession Any difference between issued and outstanding

is due to treasury stock9-22

S 9-8, p. 572

9-23

Required: Prepare stockholders’ equity section of balance sheet. Net income has already been closed to RE.

Note: All amounts have dollar amounts in thousands except for par value.

S 9-8, p. 572

Thousands

Stockholders’ equity:

Common stock, $.01 par, 400 thousand shares issued

$ 4

Paid-in capital in excess of par………………………..

196

Retained earnings………………………………………..

647

Other stockholders’ equity……………………………..

(22

)

Total stockholders’ equity………………………………

$825

9-24

E9-20A, p. 575 – transaction data

9-25

Authorized to issue 120,000 shares of common stock and 7,000 shares of preferred stock. Had following stock issuance transactions during the year:

Jan 19 – Issued 12,000 shares of $2.00 par common stock for cash of $6.00 per share

Apr 3 – Issued 400 shares of $1.00 no-par preferred stock for $54,000 cash

Apr 11 – Received inventory valued at $16,000 and equipment with market value of $9,500 for 3,700 shares of the $2.00 par common stock.

E9-20A (req. 1) – Journal - Jan 19

9-26

E9-20A (req. 1) – Journal – Apr 3

9-27

E9-20A (req. 1) – Journal – Apr 11

9-28

E9-20A (req. 2), p. 575

9-29

Given: Ending RE balance is deficit of $43,000.

Learning Objective 3

Describe How Treasury Stock Affects a Company

9-30

Treasury Stock

Company’s own stock that it has issued and later reacquired

Reasons: All authorized shares have been issued

and shares are needed for employee stock purchase plans

Company wants to purchase its shares at a low price and the re-issue them at a higher price

Management want to avoid a takeover 9-31

Accounting for Treasury Stock

Recorded at cost (not par value)

Contra-equity account (debit balance)

Reduces stockholders’ equity and assets

If sold above cost, paid-in capital from treasury stock transactions is credited

9-32

Accounting for Treasury Stock

Suppose a company purchased 10,000 shares of its own $1 par common stock for $200,000

9-33

Date Accounts Debit Credit

  Treasury stock$200,00

0  

  Cash  $200,00

0

10,000 x $2

Accounting for Treasury Stock

Later, the company resells the treasury shares for $250,000 (above cost)

9-34

Date Accounts Debit Credit

  Cash $250,00

0  

Treasury stock  $200,00

0

  Paid-in capital from treasury stock

  transactions   $50,000

(original cost)

(given above)

($250,000 - $200,000)

Retained Earnings

Balance = Net incomes – net losses – dividends declared

Accumulated earnings the company keeps

Not a reservoir of cash

Normal credit balance

Debit balance = Deficit Losses and dividends exceed earnings

9-35

Retained Earnings Balance

Credit balance

Lifetime earnings

Lifetime losses &

dividends>

Debit balance

Lifetime earnings

Lifetime losses &

dividends<

9-36

Retained Earnings

9-37

Retained Earnings

Beginning Balance

Dividends Declared

Ending Balance

Net Income

If retained earnings increases, net income > dividendsIf retained earnings decreases, net income < dividends

This slide is out of order from original slides on Vista8

S 9-10, p. 572

9-38

A corporation reported the following SE section at Dec 31 (in millions):

During the next year, the corporation purchased treasury stock at a cost of $29 million and resold treasury stock for $8 million (this stock had cost the corporation $2 million).

S 9-10, p. 572

DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT

Millions

Treasury Stock………………………………

29

Cash………………………………………..

29

Cash………………………………………......

8

Treasury Stock…………………………..

2

Paid-in Capital from Treasury Stock

Transactions………………………..6

9-39

Overall, stockholders’ equity decreased by $21 million ($29 M paid out minus $8 M received).

E9-24A, p. 576

9-40

Transactions:

Jan 17 – Issued 2,200 shares of $2.50 par common stock at $10 per share

May 23 – Purchased 300 shares of treasury stock at $12 per share

Jul 11 – Sold 200 shares of treasury stock at $20 per share

E9-24A, p. 576 – J/E on Jan 17

9-41

E9-24A, p. 576 – J/E on May 23

9-42

E9-24A, p. 576 – J/E on July 11

9-43

E9-24A, p. 576 – Effect on Equity

9-44

1/17 5,500

1/17 16,500

5/23 (3,600)

7/11 2,400

7/11 1,600

Net increase 22,400

Learning Objective 4

Account for Dividends

9-45

Dividends

Distribution to stockholders

Three forms Cash Stock Noncash assets

9-46

Cash Dividends

Company must have both: Enough Retained Earnings to declare the

dividend Enough Cash to pay the dividend

Board of Directors has authority to declare the dividend

9-47

Dividend Dates

Date of Declaration Board of Directors announces dividend Corporation is now obligated to pay

Date of record Stockholders who own shares on this date

will receive dividend

Date of payment Payment sent to shareholders on record

9-48

Accounting for Dividends

Date of Declaration

Equity Decreases; Liabilities Increase9-49

Accounts Debit Credit

Retained Earnings $$$$$  

Dividends Payable   $$$$$

Accounting for Dividends

Date of Record – no entryDate of Payment

Liabilities Decrease; Assets Decrease9-50

Accounts Debit Credit

Dividends Payable $$$$$  

Cash   $$$$$

Retained Earnings

9-51

Retained Earnings

Beginning Balance

Dividends Declared

Ending Balance

Net Income

If retained earnings increases, net income > dividendsIf retained earnings decreases, net income < dividends

We saw this slide earlier…

Preferred Dividends

Preferred shareholders receive dividends before common shareholders

Dividend rate expressed as: Percent of par value Dollar amount per share

Cumulative – any unpaid dividends are carried forward until paid Dividends in arrears

9-52

Preferred Dividends

Preferred cumulative – any unpaid dividends are carried forward until paid Dividends in arrears

Preferred noncumulative

Preferred participating

Preferred nonparticipating

9-53

Preferred Dividend Example A corporation has 10,000 shares of $100,

8% cumulative preferred stock outstanding

It also has 80,000 shares of $1 par common stock outstanding

The Board of Directors declares dividends as follows: Year 1 = $ 20,000 Year 2 = $150,000

9-54

Preferred Dividend Example

Preferred Dividend : 10,000 shares x $100 par x 8% = $80,000

9-55

Preferred Common

Year 1 $20,000 $ -

Year 2

Dividends in arrears $60,000

Current year $80,000

$140,000 $10,000

S9-13, p. 573

9-56

Access Garde, Inc., has 200,000 shares of 1.80 preferred stock outstanding in addition to its common stock. The 1.80 designation means that the preferred stockholders receive an annual dividend of $1.80 per share. In 2010, the corporation declares an annual dividend of $500,000. The allocation to preferred and common shareholders is:

Preferred (200,000 shares x $1.80 per share) = $360,000Common (Remainder $500,000 - $360,000) = 140,000 Total dividend $500,000

This slide is not in PowerPoint slides from Vista8

S9-13, p. 573

9-57

This slide is not in PowerPoint slides from Vista8

Req 1: How much in dividends must Access Garde declare each year before the common shareholders receive any cash dividends for the year?

Answer: $360,000 (200,000 shares × $1.80 per share)

S9-13, p. 573

9-58

This slide is not in PowerPoint slides from Vista8

Req 2: Suppose the company declares cash dividends of $400,000 for 2010. How much of the dividends goes to preferred? How much goes to common?

Answer: Preferred: $360,000 (200,000 shares × $1.80 per share)Common: $40,000 ($400,000 - $360,000)

S9-13, p. 573

9-59

This slide is not in PowerPoint slides from Vista8

Req 3: Is the company’s preferred stock cumulative or noncumulative? How can you tell?

Answer: The company’s preferred stock are cumulative because they are not specifically designated as noncumulative.

S9-13, p. 573

9-60

Req 4: The company passed the preferred dividend in 2009 and 2010. In 2011, the company declares cash dividends of $1,500,000. How much of the dividends goes to preferred? How much goes to common? 

Answer: Preferred: $1,080,000 ($360,000 × 3)Common: $ 420,000 ($1,500,000 − $1,080,000)

This slide is not in PowerPoint slides from Vista8

Stock Dividends

Proportional distribution of shares to stockholders

Reasons corporations distribute stock dividends: Provide dividend, yet conserve cash Reduce market price of shares

Decrease retained earnings and increase common stock Total equity is unchanged

9-61

Stock Dividends

Small Less than 25% of outstanding shares Recorded at market value

Large Greater than 25% of outstanding shares Recorded at par value

9-62

E9-29A, p. 578

9-63

On May 11, 2011, market price of the common stock was $19 per share. HD distributed a 15% stock dividend on this date.

Prepare journal entry & Stockholders’ Equity section of balance sheet.

As of Dec 31, 2010

E9-29A, p. 578 – Journal entry

9-64

Accounts Debit Credit

Retained Earnings $855,000  

Common stock   $36,000

Paid-in capital in excess of par $819,000

(300,000 × 0.15 × $19)(300,000 × 0.15 × $0.80)

$855,000 - $36,000

Market price# of shares stock dividend %

Par value

E9-29A, p. 578 – Balance sheet

9-65

E9-29A, p. 578 – Question 3

9-66

Question 3: Why is total stockholders’ equity unchanged by the stock dividend?

Answer: Company gave its shareholders no assets. Just transferred $855,000 from RE to Common Stock and Paid-in Capital in Excess of Par

E9-29A, p. 578 – Question 4

9-67

Question 4: Suppose HD had a cash balance of $560,000 on May 12, 2011. What is the maximum amount of cash dividends HD can declare?

Answer: HD’s maximum cash dividends cannot exceed the balance in Cash account, $560,000.

Stock Splits

Increase in shares coupled with a proportionate reduction in par value 2-for-1 split doubles the shares

outstanding and halves the par value

No entry made Description of stock changed on balance

sheet

9-68

Summary of Transaction Effects

9-69

Assets

= Liabilitie

s + Equity

Issue stock IncreaseNo

effect Increase

Purchase treasury stock

Decrease

No effect

Decrease

Sell treasury stock IncreaseNo

effect Increase

Declare cash dividend

No effect Increase

Decrease

Pay cash dividendDecreas

eDecreas

eNo

effect

Stock dividendNo

effectNo

effectNo

effect

Stock splitNo

effectNo

effectNo

effect

Learning Objective 5

Use Stock Values in Decision Making

9-70

Stock Value Terms

9-71

Price one can buy or sell one share of stock for; varies with company

performance and economy

Redemption value

Set price company is required to pay toretire preferred stock

Liquidation value

Required payment to preferred shareholders if the company liquidates

Book value Common equity# of common shares outstanding

Market value

Learning Objective 6

Compute Return on Assets and Return on Equity

9-72

Return on Assets (ROA)

Measures company’s use of asset to earn income for financers of the business Creditors Stockholders

9-73

Net income + Interest expense

Average total assets

Return on Equity (ROE)

Shows relationship between net income and equity Computed only on common stock

Should be higher than return on assets Stockholders risk more than bondholders

9-74

Net income – Preferred dividends

Average common stockholders’ equity

S 9-17, p. 574 (compute ROA & ROE)

9-75

S 9-17, p. 574

9-76

ROA

Net Interest

=income + expense

=¥120 + ¥31

Average total assets

(¥10,624 + ¥9,515) / 2

=¥151

= 1.5%¥10,07

0Note: 10% is considered good in most industries. Therefore, Godhi’s 1.5% return on assets is very weak.

S 9-17 (continued)

9-77

ROE

Net Preferred

=

income − dividends

=

¥120 − ¥0

Average common stockholders’

equity

(¥3,212 + ¥2,878) / 2

=¥120

= 3.9%¥3,04

5Note: 15% is considered good in most industries, so Godhi’s return on equity is very weak.

Learning Objective 7

Report Equity Transactions on the Statement of Cash Flows

9-78

Equity Transactions on the Cash Flow Statement

All equity transactions are financing activities

Financing inflow Issuing stock

Financing outflow Purchase of treasury stock Payment of dividends

9-79

S 9-19, p. 574

9-80

During 2010, Dwyer Corporation earned net income of $5.8 billion and paid off $2.4 billion of long-term notes payable. Dwyer raised $1.1 billion by issuing common stock, paid $3.5 billion to purchase treasury stock, and paid cash dividends of $1.6 billion.

Report Dwyer’s cash flow from financing activities on the statement of cash flows for 2010.

S 9-19, p. 574

Billions

Cash flows from financing activities:

Paid off long-term notes payable………………… $(2.4)

Issued common stock……………………………… 1.1

Purchased treasury stock…………………………. (3.5)

Paid cash dividends………………………………… (1.6)Cash flows from financing activities: $(6.4)

9-81

End of Chapter 9

9-82