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Chapter 11

Reporting and Interpreting Owners’ Equity

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Business Background

Advantages of a corporation

Simple to become an

owner

Easy to transfer

ownership

Provides limited liability

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Business Background

Because a corporation is a separate legal entity, it can . . .

Own assets.

Sue and be sued.

Incur liabilities.

Enter into contracts.

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Ownership of a Corporation

Rights

Voting (in person or by proxy).

Proportionate distributions of

profits.

Proportionate distributions of

assets in a liquidation.

Stockholders

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Ownership of a Corporation

Vice President(Production)

V ice President(Ma rketing)

V ice President(F ina nce)

V ice President(C ontro ller)

President

B oa rd of D irectorsInterna l (m a na gers) a ndExterna l (non-m a na gers)

Stockholders(O w ners of voting sha res)

Elected byshareholders

Appointedby directors

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Authorized, Issued, and Outstanding Capital Stock

The maximum number of shares of capital

stock that can be sold to the public.

AuthorizedShares

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Authorized, Issued, and Outstanding Capital Stock

AuthorizedShares

Issued shares are authorized shares of stock that have been

sold.

Unissued shares are authorized shares of stock that

never have been sold.

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Authorized, Issued, and Outstanding Capital Stock

AuthorizedShares

UnissuedShares

TreasuryShares

OutstandingSharesIssued

SharesTreasury shares are

issued shares that have been reacquired by the

corporation.

Outstanding shares are issued shares that are

owned by stockholders.

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Types of Capital Stock

Common Stock

Preferred Stock

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Common Stock

Basic voting stock

Ranks after preferred

stock

Dividend set by board of

directors

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Par Value and No-par Value Stock

Legal capital is the amount of capital, required by the state, that must remain

invested in the business.

Par Value

Nominal value

Legal capital

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Par Value

Par Value

Market Value

I get it!

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Preferred Stock

Preference over common

stock

Usually hasno voting

rights

Usually has a fixed dividend

rate

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Special Features of Preferred Stock

Convertible preferred stock may be exchanged for common stock.

Convertible preferred stock may be exchanged for common stock.

Callable preferred stock may be repurchased by the corporation at a

predetermined price.

Callable preferred stock may be repurchased by the corporation at a

predetermined price.

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Accounting for Capital Stock

Two primary sources of stockholders’ equity

Retained earnings

Contributed capital

Parvalue

Additional paid-in capital

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Sale and Issuance of Capital Stock

Initial public offering (IPO)

Seasoned new issue

The first time a corporation sells

stock to the public.

Subsequent sales of new stock to the

public.

Wal-Mart

issues new stock.

Wal-Mart

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Secondary Markets

Transactions between two investors that do not affect the corporation’s accounting records.(Like when you

buy and sell stock) I’d like to sell some of my

Wal-Mart stock.

I’d like to buy some of your

Wal-Mart stock.

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GENERAL JOURNAL Page 34Date Description Debit Credit

July 6

Sale and Issuance of Capital Stock

On July 6, Wal-Mart issued 100,000 shares of $0.10 par value common

stock for $22 per share.

Prepare the journal entry to record this transaction.

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GENERAL JOURNAL Page 34Date Description Debit Credit

July 6 Cash 2,200,000

Common Stock 10,000

Capital In Excess of Par Value 2,190,000

Sale and Issuance of Capital Stock

100,000 shares × $22 per share = $2,200,000

100,000 shares × $0.10 par value = $10,000

On July 6, Wal-Mart issued 100,000 shares of $0.10 par value common

stock for $22 per share.

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Treasury Stock

Wal-Mart buysits own stock in

the secondary market.

(Treasury stock) Stockholders

Management

Management compensation

package includes salary and stock

options.

Stock options allow management to purchase

stock from the corporation at a fraction of the stock’s

value in the secondary market.

Wal-Mart

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Treasury Stock

No voting or

dividend rights

Contra equity

account

When stock is reacquired, the corporation records the treasury stock at cost.

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Treasury Stock

GENERAL JOURNAL Page 27Date Description Debit Credit

May 1 Treasury Stock 2,200,000

Cash 2,200,000

100,000 shares × $22 = $2,200,000

On May 1, Wal-Mart reacquired 100,000 shares of its common stock at $22 per share.

The journal entry for May 1 is . . . .

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GENERAL JOURNAL Page 68Date Description Debit Credit

Dec. 3 Cash 300,000

Treasury Stock 220,000

Contributed Capital from

Treasury Stock Transactions 80,000

Treasury Stock

10,000 shares × $30 = $300,000

10,000 shares × $22 cost = $220,000

On December 3, Wal-Mart reissued 10,000 shares of the treasury stock at $30 per share.

The journal entry for December 3 is . . .

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Accounting for Cash Dividends

Declared by board of directors.

Not legally required.

Creates liability at declaration.

Requires sufficient Retained Earnings

and Cash.

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Dividend Dates

Declaration dateBoard of directors declares the dividend.Record a liability.

GENERAL JOURNAL Page 12

Date DescriptionPost. Ref. Debit Credit

Retained Earnings XXX

Dividends Payable XXX

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Dividend Dates

Date of RecordStockholders holding shares on this date

will receive the dividend. (No entry)

X

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Dividend Dates

Date of PaymentRecord the payment of the dividend to

stockholders.

GENERAL JOURNAL Page 12

Date DescriptionPost. Ref. Debit Credit

Dividends Payable XXX

Cash XXX

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Dividends on Preferred Stock

Current Dividend Preference: The current preferred dividends must be paid before paying any dividends to common stock.

Cumulative Dividend Preference: Any unpaid dividends from previous years (dividends in arrears) must be paid before common dividends are paid.

Current Dividend Preference: The current preferred dividends must be paid before paying any dividends to common stock.

Cumulative Dividend Preference: Any unpaid dividends from previous years (dividends in arrears) must be paid before common dividends are paid.

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Dividends on Preferred Stock

If the preferred stock is noncumulative, any dividends not declared in previous years

are lost permanently.

If the preferred stock is noncumulative, any dividends not declared in previous years

are lost permanently.

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Dividends on Preferred Stock

Kites, Inc. has the following stock outstanding:

Common stock: $1 par, 100,000 shares

Preferred stock: 3%, $100 par, cumulative, 5,000 shares

Preferred stock: 6%, $50 par, noncumulative, 3,000 shares

Dividends were not paid last year. In the current year, the board of directors

declared dividends of $50,000.

How much will each class of stock receive?

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Dividends on Preferred StockTotal dividend declared 50,000$

Preferred stock (cumulative)Arrearage ($100 par × 3% × 5,000 shares) 15,000$ Current Yr. ($100 par × 3% × 5,000 shares) 15,000 30,000

Remainder 20,000$

Preferred stock (noncumulative)

Remainder

Common stock

Remainder

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Dividends on Preferred StockTotal dividend declared 50,000$

Preferred stock (cumulative)Arrearage ($100 par × 3% × 5,000 shares) 15,000$ Current Yr. ($100 par × 3% × 5,000 shares) 15,000 30,000

Remainder 20,000$

Preferred stock (noncumulative)Current Yr. ($50 par × 6% × 3,000 shares) 9,000

Remainder 11,000$

Common stock

Remainder

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Dividends on Preferred StockTotal dividend declared 50,000$

Preferred stock (cumulative)Arrearage ($100 par × 3% × 5,000 shares) 15,000$ Current Yr. ($100 par × 3% × 5,000 shares) 15,000 30,000

Remainder 20,000$

Preferred stock (noncumulative)Current Yr. ($50 par × 6% × 3,000 shares) 9,000

Remainder 11,000$

Common stockCurrent Yr. ($11,000 Remainder) 11,000

Remainder 0$

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Focus on Cash Flows

Wal-Mart

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Accounting for Stock Dividends (Saving cash)

Distribution of additional sharesof stock to stockholders(less than 25%).

No change in total stockholders’ equity.

All stockholders retain same percentage

ownership.

No change in par values.

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Stock Splits

Distributions of 25% or more of

stock to stockholders.

Ice Cream Parlor

Banana Splits On Sale Now

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Stock Splits

Assume that a corporation had 5,000 shares of $1 par value common stock outstanding

before a 2–for–1 stock split.

Before Split

After Split

Common Stock Shares 5,000

Par Value per Share 1.00$

Total Par Value 5,000$

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Stock Splits

Assume that a corporation had 5,000 shares of $1 par value common stock outstanding

before a 2–for–1 stock split.

Increase

Decrease

No Change

Before Split

After Split

Common Stock Shares 5,000 10,000

Par Value per Share 1.00$ 0.50$

Total Par Value 5,000$ 5,000$

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Restrictions on Retained Earnings

If I loan you $150,000, I will want you to restrict your

retained earnings. Why would youwant to do that?

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Restrictions on Retained Earnings

Because I want to restrict the amount you can pay out

in dividends.

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End of Chapter 11

C’mon Chester! With your smarts and my savvy, we

could make a great partnership!!