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Chapter 12: Stockholders’ Equity

Fundamentals of Intermediate AccountingWeygandt, Kieso and Warfield

Prepared byBonnie Harrison, College of Southern Maryland,

LaPlata, Maryland

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Chapter 12Stockholders’ Equity

After studying this chapter, you should be able to:Discuss the characteristics of the corporate form of

organization.Explain the key components of stockholders’ equity.Explain the accounting procedures for issuing shares

of stock.Explain the accounting for treasury stock.Explain the accounting for and reporting of preferred

stock.

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Chapter 12Stockholders’ Equity

After studying this chapter, you should be able to:Describe the policies used in distributing dividends.Identify the various forms of dividend distributions.Explain the accounting for small and large stock

dividends, and for stock splits.Indicate how stockholders’ equity is presented and

analyzed.

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Corporate Form: Characteristics

Accounting for the corporate form is affected by:

the influence of state corporate law the use of capital stock the variety of ownership interests the limited liability of the stockholders the formality of the profit distribution

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The Rights of Stockholders

The stockholders have the right to:1) share proportionately in profits and losses2) share proportionately in management3) share proportionately in corporate assets upon

liquidation4) share proportionately in any new issues of stock

of the same class (preemptive right)

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Components of Stockholders’ Equity

Stockholders’ equity is classified into: contributed capital, and earned capital Contributed capital (paid-in capital) :1. is the amount advanced by stockholders for use

in the business, and2. includes the par value of stock and any premium

or discount on issuance of stock Earned capital consists of undistributed profits

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Components of Equity

EQUITY

Earned capital(Ret. Earn).

CONTRIBUTED CAPITAL

Less:T.Stockat COST

Less: T.stockat PAR

Restrict UNrest Paid-incapital

AdditionalPaid-in

common preferred common preferred

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Stockholders’ Liability

It is the stockholders’ liability that is limited - NOT the company’s !

If PAR issue, liability is limited to amount invested by stockholder.

If PREMIUM issue, liability is limited to total investment by stockholder.

If DISCOUNT issue, liability equals amount invested plus discount at issue.

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Accounting for Share Issues

Accounts must be maintained for: par value stock preferred stock or common stock paid-in capital in excess of par discount on stock No par stock preferred stock or common stock paid-in capital in excess of par Stock sold on a subscription basis

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Par Value stock:– Record Common stock at PAR

No-Par Stock:– Entire sale proceeds go to Stock account.– Avoids stockholders’ contingent liability in

discount stock issues– Avoids confusion between par and market

values

Equity - Stock Issues

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Stock Issued in Lump-sum Sales Both COMMON and PREFERRED stocks are

issued for cash in a single transaction The two methods of allocation available are:1) Proportional Method [relative fair market values]2) Incremental Method

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Sale of Stock for Lump-sum: Example

Corporation issues common and preferred stock for lump-sum cash:

common stock: 1,000 shares; par, $10; fair market value, $20:

preferred stock: 1,000 shares ; par, $10; fair market value, $12;

cash received for issue: $30,000: Show the allocation of cash under the Proportional

method

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Sale of Stock for Lump-sum: Example

ProportionalAllocate cash received based on fair values of common and preferred stock:

Allocate to common stock: ( 20000 / 32000) * 30,000 = $18,750

Common

Allocate to preferred stock: (12000 / 32000) * 30,000 = $11,250

Preferred

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Sale of Stock for Lump-sum

Corporation issues common and preferred stock for lump-sum cash:

Common stock: 1,000 shares; par, $10; fmv, $20; Preferred stock: 1,000 shares ; par, $10; (fair market value of preferred stock, NOT clear.) Cash received for issue: $30,000.

Show the allocation of cash under the Incremental method

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Sale of Stock for Lump-sum

Incremental Cash Received: $30,000Fair market value(c/st): (20,000)

======Amount allocated to preferred stock $10,000 ======

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Stock Issuance for Other Than Cash

When stock is issued for services or property other than cash, the property or services are recorded at

1) either the fair value of the stock issued OR

2) the fair value of non-cash consideration received, whichever is more clearly determinable

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Treasury Stock Outstanding stock, purchased by the corporation, is known

as treasury stock. The reasons as to why corporations buy back their

outstanding stock include:

1) to increase earnings per share and return on equity2) to provide tax efficient distributions of excess cash to

shareholders3) to provide stock for employee stock compensation

contracts 4) to thwart takeover attempts5) to create or improve the market for the stock

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Treasury Stock: Concepts Treasury stock represents reacquired (outstanding)

common stock Treasury stock IS NOT an asset Steps in treasury stock transactions:1) Initially, corporations issue stock from authorized

stock2) From issued (and outstanding) stock, corporations

may reacquire the stock [=T/Stock]3) Treasury stock may be resold: when resold, it

becomes issued stock.4) T/Stock may be retired or removed from the

books.

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Recording Treasury Stock: Methods

COST METHOD:– Treasury stock is recorded at purchase COST– It is a CONTRA-EQUITY account (shown as a

reduction of equity in the Stockholders’ Equity section)

PAR VALUE METHOD:– Treasury stock is recorded at PAR value– It is a contra account to the common stock

account

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Treasury Stock: Cost Method The cost method is generally used to account for

treasury stock Under the cost method:1) debit treasury stock for purchase cost, and2) credit treasury stock for this same cost upon reissue The initial issue price of stock does not affect

subsequent treasury stock transactions

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Treasury Stock: Cost Method Given:1) Issued: 1,000 common shares; Par, $100;

issued at $110.2) Reacquired: 100 shares at $112 each.3) 10 shares were reissued at $112 (at cost)4) 10 shares were reissued at $130 (above cost)5) 10 shares were reissued at $98 (below cost)6) 10 shares reissued at $105 (below cost) Show journal entries for the stock transactions

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Treasury Stock: Cost MethodDebit Credit

Issued: (par, $100);1,000 sh. at $110.

Cash 110,000 Common stock 100,000 Additional PIC: common stock 10,000

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10 shares reissued @ 112

Cash 1,120 Treasury stock 1,120

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Reacquired: 100 at $112.

Treasury stock 11,200 Cash 11,200

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Treasury Stock: Cost MethodDebit Credit

10 shares reissued at 130

Cash 1,300 Treasury stock 1,120 Additional PIC: Treasury stock 180

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10 shares reissued at $98

Cash 980 Additional PIC: (T/stock) 140 Treasury stock 1,120

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Treasury stock: cost method- contd.

Cash 1,050Addl PIC (t/stock) 40Retained Earnings 30 Treasury stock 1120

Reissued 10 treasury shares at $1056

Use Additional PIC (treasury stock) firstto absorb any shortfall. Then, use retained

earnings

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RETIREMENT OF TREASURY STOCK

Repurchase of stock does NOT mean retirement Retired stock must be cancelled. Retired stock becomes authorized and unissued

stock Similar to sale of treasury stock, except debits are

made to Paid in Capital accounts (instead of cash)

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Treasury stock: Retirement (cost method)

Given: 10 treasury shares are retired. Common shares (par, $100) had originally been

issued at $110. Provide the journal entries under the following

assumptions:1) The 10 shares of treasury stock were acquired at

$112.2) The 10 shares of treasury stock were acquired at

$98.

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Treasury stock: Retirement (cost method)

Treasury stock, acquired at $112:

C/stock 1,000PIC:c/st 100Ret.Earn . 20 T/Stock 1,120

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Treasury stock, acquired at $98.

C/stock 1,000PIC: c/st 100 T/stock 980 PIC: from retired common st 120

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Preferred Stock

Preferred stock has certain preferences or featuresnot possessed by common stock

These features include:1) preference as to dividends 2) preference as to assets in the event of liquidation3) convertibility into common stock at the option of the

stockholders4) callability at the option of the corporation5) absence of voting rights

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Preferred Stock: Features

Cumulative preferred stock Participating preferred stock:

– Fully Participating– Partially Participating

Convertible preferred stock Callable preferred stock Redeemable preferred stock , not equity

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Restricted Payment of Dividends

Dividend payments may be subject to covenant restrictions

No dividends are payable on treasury stock Earnings may be reinvested Corporation may smooth out dividends paid

over the years (to avoid fluctuations) Corporations may build up a cushion of

profits

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Types Of Dividends

1) Cash dividends2) Property dividends3) Stock dividends4) Liquidating dividends [return of capital]

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Cash Dividends: Important Dates

There are three important dates:1. the declaration date (dividends are declared

and accrued)2. the record date (list of stockholders to whom

dividends are to be paid is finalized)

3. the payment date (dividends are paid to stockholders of record)

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Cash Dividends: Journal Entries

1) DATE DECLARED

2) DATE OF RECORD

3) DATE of PAYMENT

1) Retained EarnDividends

Payable2) No Entry

3) Dividends PayableCash

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PROPERTY DIVIDENDS

are payable in assets of company are non-reciprocal transfers between

corporation and shareholders are equal to the fair market value of assets

distributed at time of declaration [except in spin-offs and reorganizations]

Corporation recognizes gain / loss on the distribution.

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Property Dividend:Entries Given: Company distributes certain marketable

securities to stockholders. Dividend is declared on Dec 21, 2002 and is

payable on Jan 21, 2003 to stockholders of record on Jan 14, 2003.

Fair value of securities is $134,000 on Dec 21, 2002 and $ 135,900 on Jan 21, 2003.

COST of securities is $ 110,000. Provide the journal entries on the dates of

declaration, record, and payment.

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Property Dividend:Entries

1 Declaration DateInvestments 24,000 Gain on Apprec. 24,000

2 Declaration DateRetain. Earn 134,000 Prop. Div.Pay. 134,000

3 Payment DateProp. Div. Pay 134,000 Investments 134,000

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LIQUIDATING DIVIDENDS are a return of corporate paid-in capital might be distributed, when corporation is

winding up operations are specified as to income and capital

portions reduce paid-in capital.

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Stock Dividends: Concept Stock dividends result in more shares being issued

as dividend (no assets are involved) Small stock dividends involve issues of less than

20% - 25% of stock. The accounting for small stock dividends is based

on the fair market value of stock issued. The accounting for large stock dividends (more

than 20%-25%) is based on the par value of stock issued.

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Stock Dividends

Types of Dividends

Less than 20 - 25% shares

More than20 - 25% shares

Use FMVat declaration

Use parvalue

Small Dividend Large dividend

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Stock Dividends: Journal Entries

Given: Outstanding stock: 1,000 shares; $10 par Stock dividend: 10% FMV on date of declaration: $12

Provide the journal entries on the declaration date and the distribution date

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Stock Dividends: Small Issue

Declaration Ret. Earnings $1,200 C/stock Distributable $1,000 Paid-in Capital (excess) 200

Distribution C/ stock distributable $1,000 Common stock $1,000

Stock dividend = 10% of 1,000 shares = 100 shares

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Stock Dividends: Large Issue Given: Outstanding stock: 3,000 shares; $10 par Stock dividend: 30% FMV on date of declaration: $12

Provide the journal entries on the declaration date and the distribution date

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Stock Dividends: Large Issue

Declaration Ret. Earnings $9,000 C/stock Distributable $9,000

Distribution C/ stock distributable $9,000 Common stock $9,000

Stock dividend = 30% of 3,000 shares = 900 shares

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STOCK SPLITS Each share is made smaller Par value of each share decreases; number of

shares increases Total par value is unchanged Stock splits do not change total equity No formal journal entry is made to record stock

splits [only a memo entry is made] Splits make shares more accessible to the public

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Stock Dividends and Stock Splits

1) Par value of a share does not change

2) Total number of shares increases

3) Total stockholders’ equity does not change

4) The composition of equity changes (less of retained earnings; more of stock)

5) Stock dividends require journal entries

1) Par value of a share decreases

2) Total number of shares increases

3) Total stockholders’ equity does not change

4) The composition of equity does not change (same amounts of stock and RE)

5) Stock splits do not require journal entries

Stock Dividends Stock Splits

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Presentation of Stockholders’ Equity

Frequently presented in the following basic format:

Balance at the beginning of the periodAdditionsDeductionsBalance at the end of the period

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