Session 11 - Shareholder Equity

8/13/2019 Session 11 - Shareholder Equity

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Private and Confidential

Equity Analyst Training Programers

Equity

1Private and Confidential Not for Circulation

Prepared by: Dheeraj Vaidya

[email protected]

[email protected]

Sharehold


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Discussion topics

Capital Stock Corporate form of Organization

Corporation - Owners Equity

Common Stock

Preferred Stock

Cumulative Preferred Stock

Convertible Preferred Stock

Dividendsers

Equity

Private and Confidential Not for Circulation 2

Dividend Policy

Cash Dividends

Property Dividends

Stock Dividends

Stock Dividends Small

Stock Dividends Large

Stock Split

Treasury Stock

Other Comprehensive Income

Statement of changes in shareholders equity

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Capital Stockers

Equity

3Private and Confidential Not for Circulation

Private and Confidential Not for Circulation

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Corporate form of Organization

Business forms

Proprietorship Partnership Corporation

Ownership Rules: One owner

Personal Liability: Unlimited

Ownership Rules: Unlimited

number of shareholders allowed;no limit on stock classes

Ownership Rules: Unlimited

number of general partnersallowed

ers

Equity


obligations of the business

Tax Treatment: Entity nottaxed, as the profits and lossesare passed through to the soleproprietor

Mgmt of the Business: Soleproprietor manages the business

Capital Contributions: Soleproprietor contributes whatevercapital needed

Personal Liability: Generallyno personal liability of theshareholders for the obligationsof the corporation

Tax Treatment: Corporationtaxed on its earnings at thecorporate level and theshareholders have a further tax

on any dividends distributed(double taxation)

Mgmt of the Business: Boardof Directors has overallmanagement responsibility andofficers have day-to-dayresponsibility

Capital Contributions:Shareholders typically purchasestock in the corporation, eithercommon or preferred

Personal Liability: Unlimitedpersonal liability of the generalpartners for the obligations of thebusiness

Tax Treatment: Entity nottaxed as the profits and lossesare passed through to thegeneral partners

Mgmt of the Business:General partners have equalmanagement rights, unless theyagree otherwise

Capital Contributions:General partners typicallycontribute money or services tothe partnership, and receive aninterest in profits and losses

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Corporation - Owners Equity

Stockholders equity is the residual interest of the stockholders in the assets of thecorporation

Two primary sources of Equity Contributed Capital and Retained Earnings

Total OwnersEquity

Paid-in CapitalRetainedEarningse

rs

Equity


Retained Earnings account is linked to the Income Statement

Preferred Stock

Par or StatedValue

Additional Paid-In Capital

Common Stock

Par or StatedValue

Additional Paid-In Capital

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Capital Stock

Authorized Capital Stock

When a corporation is formed, the individuals who file the corporate charter with the state must firstdetermine the maximum number of shares the corporation will be authorized to issue

Authorized capital stock is the number of shares authorized for issue by the corporate charter

Authorized stock must allow for future flexibility so usually the authorized stock is more than the numberof shares the corporation plans to issue in the foreseeable future

Issued Shares

The number of shares that have been sold

Outstanding shares

ers

Equity


The number of shares still in circulation

Outstanding Shares Issued Stock Treasury Stock= -

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Common Stockers

Equity

7Private and Confidential Not for CirculationPrivate and Confidential Not for Circulation

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Common Stock

McDonalds Shareholders Equity in 2006 and 2007

McDonald's Part - Balance Sheet ($ in mn, expect per share data) 2007 2006

Shareholders' Equity

Preferred stock, no par value; authorized 165.0 million shares; issued none $0 $0

Common stock, $.01 par value; authorized 3.5 billion shares; issued 1,660.6 million shares $17 $17

Additional paid-in capital $4,227 $3,445

Retained earnings $26,462 $25,846

Accumulated other comprehensive income (loss) $1,337 ($297)

Common stock in treasury, at cost; 495.3 and 456.9 million shares ($16,762) ($13,552)

Total shareholders e uit 15 280 15 458ers

Equity


Authorized

Preferred

Stock, 165

Authorized

Common

Stock, 3,500

Shares

Issued, 1,661

Treasury

Shares, 495

Shares

Unissued, 1,509

McDonalds authorized shareholders

stock in 2007

McDonalds stock distribution

in 2007

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Common Stock

Each share of common stock conveys certain rights to the owner:

Attend stockholders meetings

Elect directors and vote on other matters

Receive dividends as declared by the board of directors

Preemptive right: The preemptive right is a shareholders right to purchase a proportionate amount ofany new stock issued at a later date

Shareholders Accounts need to be maintained for

Par Value (Par value has no economic significance)

Additional Paid-in Capitalers

Equity


When par value stocks are issued:

When no-par value stocks are issued:

What is the par value for McDonalds ?

Why par value is so low?

Low par values help companies avoid a contingent liability.

Avoids confusion over recording par value versus fair market value.

Cash ProceedsNumber of Shares X

Par Value of StockPaid in capital in excess

of Par Value= +

Cash ProceedsCommon Stock

Proceeds=

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Common Stock

Cash proceeds $500,000

Common stock $10,000

Additional paid-in capital $490,000

Cash proceeds = $50 x 10,000 =$500,000

Common Stock = $1 x 10,000 =$10,000

Additional aid-in ca ital

Example: Common Stock90 degrees Corp issued 10,000 shares of $1 par value stock for $50/share. What is common stock

and additional paid-in-capital?

ers

Equity


Costs of Issuing Stock includes direct costs incurred to sell stock, such as

Underwriting costs

Accounting and legal fees,

Printing costs

Taxes

Cost of issue should be reported as a reduction of the amounts paid in (additional paid-incapital)

($50 - $1) x 10,000 = $490,000

Sharehold


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Preferred Stockers

Equity


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Preferred Stock

Preferred stock has certain preferences or features not possessed by common stock

These features are:

Preference as to dividends

Absence of voting rights

Preference as to assets in the event of liquidation

May be convertibility into common stock at the option of the stockholders (Convertible Preferred Stock)

May be callable at the option of the issuer (Callable Preferred Stock)

These may also come with attached warrants (Preferred stock with stock warrants)

ers

Equity


Cumulative

All dividends must be paid before any

dividends can be paid to common shareholders

Cumulative

All dividends must be paid before any

dividends can be paid to common shareholders

Non-cumulative

If dividends are not paid, the company is not

required to make-up the missed dividends

Non-cumulative

If dividends are not paid, the company is not

required to make-up the missed dividends

Preferred Stock

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Cumulative Preferred Stock

Example: Preferred StockFollowing the previous example, 90 degree Corp also issued 1,000 shares of no par value, $5 cumulative

preferred stock for $80/share.

Net Income (2007) = $150,000

Dividends (2007) = $0

Calculate the total shareholder's equity?


Preferred stock capital $80,000

Preferred stock capital

= $80 x 1,000 = $80,000ers

Equity


Dividends of $5 cumulative preferred stock?

In arrears on cumulative preferred stock = $5,000 (1,000 share x $5/share)

90 degree Corp

Balance Sheet, 31st Dec 2007

Preferred shares (1,000 no par value ) $80,000

Common Stock (10,000 shares @ $1 par value $10,000

Additional paid-in capital (common stock) $490,000

Retained Earnings $150,000

Total Shareholders' Equity $730,000

Flows from the income statement

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Convertible Preferred Stock


Preferred stock, $100 par $50,000

Preferred stock Additional paid- in Capital $25,000

Upon conversion of the preferredconvertible stocks

Example: Convertible Preferred Stock

Following the previous example, 90 degree Corp has also issued 500 shares of $100 par convertible

preferred stock for $150/share.

Each share of preferred stock may be converted into three shares of $1 par common stock

ers

Equity


Each preferred is converted into threecommon stock

$1 x 500 x 3 = $1,500


Common stock, $1 par $1,500

Additional paid-in capital from preferred stock $73,500

90 degree Corp

Balance Sheet, 31st Dec 2007Preferred shares (1,000 no par value ) $80,000

Convertible preferred shares ($100 par value ) $50,000

Preferred stock Additional paid- in Capital $25,000

Common Stock (10,000 shares @ $1 par value $10,000




Before conversion ofpreferred stock

Sharehold


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Dividendsers

Equity


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Dividend Policy

Dividend distributions generally are based on accumulated profits (retained earnings)

Few companies pay dividends in amounts equal to their legally available retained earnings.

Maintain agreements with creditors

Meet state incorporation requirements

To finance growth or expansion

To smooth out dividend payments

To build up a cushion against possible losses

Important types of Dividendsers

Equity


DividendsDividends

CashdividendsCash

dividends

PropertydividendsPropertydividends

StockdividendsStock

dividends

Dividends require information concerningthree dates

Date of declaration

Date of record

Date of payment

Dividends require information concerningthree dates

Date of declaration

Date of record

Date of payment

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Cash Dividends

Board of directors vote on the declaration of cash dividends

The company must have sufficient cash and retained earnings to pay the dividend

Companies do not declare or pay cash dividends on treasury stock

Company is not legally required to pay dividends, but once declared a legal liability is created

Example: Cash Dividend

What would be the accounting entries made by a corporation that declared a $100,000 cash dividend on

March 15, payable on April 20 to shareholders of record on April 2?ers

Equity


Date of Declaration (March 15th, 2008)

Date of Record (April 2nd, 2008) NO ENTRY

Date of Payment (April 20th, 2008)

Assets Liability Shareholders Equity= +

Retained Earningsdecreases by $100,000

Dividends payableincreases by $100,000


Cash decreases by$100,000

Dividends payabledecreases by $100,000

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Property Dividends

Sometimes a corporation will declare a property dividend that is payable in assets other thancash

The corporation typically uses marketable securities of other companies that it owns for theproperty dividend

Gain on Investments = ($135,000 - $100,000) = $35,000

th

Example: Property Dividend

A dividend is declared January 5, 2008 and paid January 25,2008 in bonds held as an investment; the bonds

have a book value of $100,000 and a fair market value of $135,000. The record date is January 20th, 2008

ers

Equity


,

Date of Record (January 20th, 2008) NO ENTRY

Date of Payment (January 25th, 2008)


Retained Earningsdecreases by $135,000

Dividends payableincreases by $135,000


Investment in bondsdecreases by $135,000

Dividends payabledecreases by $135,000

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Stock Dividends

Issuance of own stock to stockholders on a pro rata basis, without receiving anyconsideration

Shareholder's do not receive corporate assets and their percentage ownership does notchange

Advantages of Stock Dividends

The stockholders may see the stock dividend as evidence of corporate growth

The stockholders may see the stock dividend as evidence of sound financial policy

Other investors may see the stock dividend in a similar light, and increased trading in the stock maycause the market price not to decrease proportionally

ers

Equity


,attractive to additional investors so that the market price may eventually rise

Accounting for Stock Dividends

StockDividends

Small (20%to 25%)

Fair Value

RetainedEarnings

CapitalStock

Additionalpaid-incapital

Large

Par Value

RetainedEarnings

CapitalStock

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Stock Dividends - Small

90 degree Corp

Balance Sheet (Prior to dividends declaration)

Common Stock (10,000 shares @ $1 par value) $10,000



Prior to dividend

declaration

Prior to dividend

declaration

ers

Equity

Example: Stock Dividend (Small)90 Degree Corp has declared and issued a 20% stock dividend. On the date of declaration, the stock sells

at $50/share. Show the accounting entries


o a are o ers qu y ,

90 degree Corp

Balance Sheet (Post to dividends declaration)



Retained Earnings $50,000Total Shareholders' Equity $650,000

Post dividend declarationPost dividend declaration

Additional Common Stock:

$1 x 10,000 X 20% = $2,000

Additional Paid in Capital due to stockdividends

$($50-$1) x 10,000 X 20% = $98,000

Retained Earnings reduces

$150,000 - $100,000

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Stock Dividends - Large

90 degree Corp

Balance Sheet (Prior to dividends declaration)




Prior to dividend

declaration

Prior to dividend

declaration

ers

Equity

Example: Stock Dividend (Large)90 Degree Corp has declared and issued a 40% stock dividend. On the date of declaration, the stock sells

at $50/share. Show the accounting entries


o a are o ers qu y ,

Post dividend declarationPost dividend declaration

Additional Common Stock:

$1 x 10,000 X 40% = $4,000

NO CHANGE

Retained Earnings reduces

$150,000 - $4,000 = $146,000

90 degree Corp

Balance Sheet (Post to dividends declaration)



Retained Earnings $146,000Total Shareholders' Equity $650,000

Sharehold


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Stock Split

Typically done to reduce the market value of shares

No entry recorded for a stock split

Decrease par value and increase the number of shares

Example: Stock Split

90 Degree Corp has done a 2:1 stock split.Show the accounting entries

90 degree Corp

Balance Sheet (Prior to Stock Split)

ers

Equity


ommon toc , s ares par va ue ,




90 degree Corp

Balance Sheet (Post Stock Split)Common Stock (20,000 shares @ $0.5 par value) $10,000




Total number of sharesincreases to 20,000 and par

value decreases to$0.5/share

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Treasury Stock

Treasury stock is a corporations own capital stock that

Has been fully paid for by stockholders

Has been legally issued

Reacquired by the corporation

Held by the corporation for future reissuance

Rationale for Stock Repurchase

To provide tax-efficient distributions of excess cash to shareholders

ers

Equity


o ncrease earn ngs per s are an re urn on equ y

To provide stock for employee stock compensation contracts or to meet potential merger needs

To thwart takeover attempts or to reduce the number of stockholders

To make a market in the stock

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Other Comprehensive Income

Comprehensive income includes both net income and other comprehensive income

Accumulated other comprehensive income might include four items

Unrealized increases (gains) or decreases (losses) in the market value of investments in available-for-salesecurities

Transaction adjustments from converting the financial statements of a companys foreign operations intoU. S. dollars

Certain gains and losses on derivative financial instruments

Certain pension liability adjustments

A corporation may report its comprehensive income

ers

Equity


On the face of its income statement

In a separate statement of comprehensive income

In its statement of changes in stockholders equity

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Statement of changes in shareholders equity

Although not a required separate financial statement, some corporations include a statement

of retained earnings in their financial statements

What information does this statement provides?

Look at the McDonalds Statement of Shareholders Equity

ers

Equity


Sharehold

Documents

Session 11 - Shareholder Equity