Principles of Accounting II Week 3: Equity and Investments 1Dr. Johnnie R. Bejarano, DBA, CPA, CFE, CGMA, CGFM

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Principles of Accounting II

Week 3: Equity and Investments

Dr. Johnnie R. Bejarano, DBA, CPA, CFE, CGMA, CGFM

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Agenda

• Review Week 2 – Liabilities• Review Homework• Discuss Chapters 11 and 12 • Demonstration Problem• Learning Assessment Tool• Preview Next Week – Financial Statement

Analysis


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1. Business Forms of Organization

• Corporations– Types (S, C, LLC)– Characteristics• Separate legal existence• Limited liability of stockholders• Transferable ownership rights• Continuous life

– Articles of incorporation (Secretary of State)– State grants charter, By-laws developed


http://www.investopedia.com/video/play/corporate-structure

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2. Issuing Stocks for Cash or Trade

• Common stock• Preferred stock• Par versus no-par stock• Stock splits• Treasury stock


http://www.investopedia.com/video/play/what-are-stocks

http://www.investopedia.com/video/play/understanding-stock-splits

http://www.investopedia.com/video/play/understanding-stock-splits

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Illustration: Assume that Hydro-Slide, Inc. issues 2,000 shares of $1 par value common stock. Prepare Hydro-Slide’s journal entry if (a) 1,000 share are issued for $1 per share, and (b) 1,000 shares are issued for $5 per share.

Cash 1,000

Common stock (1,000 x $1) 1,000

Cash 5,000

Common stock (1,000 x $1) 1,000

Paid-in capital in excess of par value 4,000

a.

b.

Accounting for Common Stock IssuesAccounting for Common Stock Issues

Issuing Par Value Common Stock for Cash


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Illustration: Assume that Hydro-Slide, Inc. issues 5,000 shares of $5 stated value no-par common stock for $8 per share. The entry is:

Cash 40,000

Common stock (5,000 x $5) 25,000

Paid-in capital in excess of stated value 15,000


Issuing No-Par Common Stock for Cash

Prepare the entry assuming there is no stated value?

Cash 40,000

Common stock 40,000


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Issuing Common Stock for Services orNoncash Assets

Corporations also may issue stock for:

Services (attorneys or consultants).

Noncash assets (land, buildings, and equipment).


Cost is either the fair market value of the consideration given up, or the fair market value of the consideration received, whichever is more clearly determinable.


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Illustration: Assume that attorneys have helped Jordan Company incorporate. They have billed the company $5,000 for their services. They agree to accept 4,000 shares of $1 par value common stock in payment of their bill. At the time of the exchange, there is no established market price for the stock. Prepare the journal entry for this transaction.

Organizational expense 5,000

Common stock (4,000 x $1) 4,000

Paid-in capital in excess of par 1,000



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Illustration: Assume that Athletic Research Inc. is an existing publicly held corporation. Its $5 par value stock is actively traded at $8 per share. The company issues 10,000 shares of stock to acquire land recently advertised for sale at $90,000. Prepare the journal entry for this transaction.

Land (10,000 x $8) 80,000

Common stock (10,000 x $5) 50,000

Paid-in capital in excess of par 30,000



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3. Cash Dividends

• Common stock• Preferred stock– Cumulative– Noncumulative

• Three important dates– Declaration date– Date of record– Date of payment


http://www.investopedia.com/video/play/what-is-dividend

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4. Non-Cash Dividends

Stock dividends


Reasons why corporations issue stock dividends:

1. To satisfy stockholders’ dividend expectations

without spending cash.

2. To increase the marketability of the corporation’s

stock.

3. To emphasize that a portion of stockholders’ equity

has been permanently reinvested in the business.

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5. Retained Earnings

• Retained earnings restrictions– Legal– Contractual (debt covenants)– Voluntary

• Prior period adjustments– Material mistakes or corrections– Fraud

• Retained earnings statement


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6. Treasury Stocks

• Purchasing• Disposing• Reporting


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Treasury stock (4,000 x $8) 32,000

Cash 32,000

Illustration: On February 1, 2011, Mead acquires 4,000 shares of its stock at $8 per share.

Accounting for Treasury StockAccounting for Treasury Stock

Illustration 11-8


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Accounting for Treasury StockAccounting for Treasury Stock

Stockholders’ Equity with Treasury stock

Both the number of shares issued (100,000), outstanding (96,000), and the number of shares held as treasury (4,000) are disclosed.

Illustration 11-9


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Retained Earnings StatementRetained Earnings Statement

Illustration 11-25


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Size of Stock Dividends

Small stock dividend (less than 20–25% of the corporation’s issued stock, recorded at fair market value)

Large stock dividend (greater than 20–25% of issued stock, recorded at par value)

Stock DividendsStock Dividends

* This accounting is based on the assumption that a small stock dividend will have little effect on the market price of the outstanding shares.

*


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10% stock dividend is declared

Retained earnings (50,000 x 10% x $15) 75,000

Common stock dividends distributable 50,000

Paid-in capital in excess of par value

25,000

Stock issued

Common stock dividends distributable

50,000

Common stock 50,000

Illustration: Medland Corp. has 50,000 shares issued and outstanding. The par value is $10 per share and market value is $15 per share.

Stock DividendsStock Dividends


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7. Owner’s Equity

• Presentation of data• Analysis of data


http://www.investopedia.com/video/play/fundamental-versus-technical-analysis

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8. Investments

• Why invest in debt or stock securities?– Make use of excess cash– Generate more earnings– Strategic reasons


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0 --------------20% ------------ 50% -------------- 100%No significant influence usually exists

Significant influence usually exists

Control usually exists

Investment valued using Cost Method

Investment valued using Equity Method

Investment valued on parent’s books using Cost Method or Equity Method (investment eliminated in Consolidation)

Ownership PercentagesOwnership Percentages

Accounting for Stock InvestmentsAccounting for Stock Investments

The accounting depends on the extent of the investor’s influence over the operating and financial affairs of the issuing corporation.


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Companies use the cost method. Under the cost method, companies record the investment at cost, and recognize revenue only when cash dividends are received.

Cost includes all expenditures necessary to acquire these investments, such as the price paid plus any brokerage fees (commissions).

Holdings of Less than 20%



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July 1

Holdings of Less than 20%Holdings of Less than 20%

Illustration: On July 1, 2011, Sanchez Corporation acquires 1,000 shares (10% ownership) of Beal Corporation common stock. Sanchez pays $40 pershare plus brokerage fees of $500. The entry for the purchase is:

Stock investments 40,500

Cash 40,500


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Holdings Between 20% and 50% (Equity

Method)Record the investment at cost and subsequently adjust the amount each period for

the investor’s proportionate share of the earnings (losses) and

dividends received by the investor.

If investor’s share of investee’s losses exceeds the carrying amount of the investment, the investor ordinarily should discontinue applying the equity method.



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Illustration: Milar Corporation acquires 30% of the common shares of Beck Company for $120,000 on January 1, 2011. For 2011, Beck reports net income of $100,000 and paid dividends of $40,000. Prepare the entries for these transactions.


Cash 120,000

Cash 12,000



Revenue from investments 30,000

Holdings Between 20% and 50%Holdings Between 20% and 50%

($40,000 x 30%)

($100,000 x 30%)

Jan. 1

Dec. 31

Dec. 31


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Controlling Interest - When one corporation acquires

a voting interest of more than 50 percent in another

corporation

Investor is referred to as the parent.

Investee is referred to as the subsidiary.

Investment in the subsidiary is reported on the parent’s

books as a long-term investment.

Parent generally prepares consolidated financial

statements.

Holdings of More Than 50%



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Valuing and Reporting InvestmentsValuing and Reporting Investments

Categories of Securities

Companies classify debt and stock investments into three

categories:

Trading securities

Available-for-sale securities

Held-to-maturity securities

These guidelines apply to all debt securities and all stock investments in which the holdings are less than 20%.


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Trading Securities

Companies hold trading securities with the

intention of selling them in a short period.

Trading means frequent buying and selling.

Companies report trading securities at fair value,

and report changes from cost as part of net

income.


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Illustration: Investment of Pace classified as trading securities on December 31, 2011.

Trading SecuritiesTrading Securities

The adjusting entry for Pace Corporation is:

Dec. 31 Market adjustment—trading 7,000

Unrealized gain—income 7,000

Illustration 12-7


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Available-for-Sale Securities

Companies hold available-for-sale securities with the intent of selling these investments sometime in the future.

These securities can be classified as current assets or as long-term assets, depending on the intent of management.

Companies report securities at fair value, and report changes from cost as a component of the stockholders’ equity section.


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Illustration: Assume that Ingrao Corporation has two securities that it classifies as available-for-sale.

The adjusting entry for Ingrao Corporation is:

Dec. 31 Unrealized gain or loss—equity 9,537

Market adjustment—available-for-sale 9,537

Illustration 12-8

Available-for-Sale SecuritiesAvailable-for-Sale Securities


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Also called marketable securities, are securities

held by a company that are

(1) readily marketable and

(2) intended to be converted into cash within the

next year or operating cycle, whichever is

longer.

Short-Term Investments

Investments that do not meet both criteria are classified as long-term investments.

Balance Sheet Presentation



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Nonoperating items related to investments

Presentation of Realized and Unrealized Gain or Loss

Balance Sheet PresentationBalance Sheet Presentation

Illustration 12-10


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Realized and Unrealized Gain or Loss

Balance Sheet PresentationBalance Sheet Presentation

Unrealized gain or loss on available-for-sale securities are reported as a separate component of stockholders’ equity.

Illustration 12-11


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Classified Balance Sheet (partial)

Illustration 12-12


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Consolidated Balance Sheet

Preparing Consolidated Financial StatementsPreparing Consolidated Financial Statements

Illustration 12A-1


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Discussion Questions - Alpha

• Why would a company choose to form as a corporation?

• What are the steps that are required to become a corporation?

• What are the advantages and disadvantages of the corporate form of doing business?


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Discussion Questions - Bravo

• Why is preferred stock referred to as preferred?

• What are some of the features that are added to preferred stock to make it more attractive to investors?

• Would you select preferred stock or common stock as an investment? Explain why.


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Discussion Questions - Charlie

• What are the different types of dividends that corporations may issue?

• When should a corporation pay dividends?• Would you prefer a stock dividend or a cash

dividend? Explain why.


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Discussion Questions - Delta

• Why do corporations buy back their own stock?

• What does it tell you about the corporation?• What affect does the purchase have on the

price of a company’s stock? • If so, is this ethical? Explain why.


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Next Week

Financial Statement Analysis


Documents

Principles of Accounting II Week 3: Equity and Investments 1Dr. Johnnie R. Bejarano, DBA, CPA, CFE, CGMA, CGFM