©The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin

Chapter Eleven

Accounting For Equity Transactions

Chapter Eleven Riddle

What Do You Get When You Cross A Snowman With A Vampire?Answer = Frostbite.Vocabulary Lesson: “Parasites” What you see from the top of the

Eiffel Tower!

“Terminology” for Owners’ Equity

To “look at” on your own: Textbook “Downloaded file” from web page on

Stockholders’ Equity terminology Next 27 Ready Notes slides

We will also cover most of the items in going over the Class Example Handout Problem for Ch. 11: Preformatted Excel Worksheet ‘Avi’ file

Formation of Business Organizations

A sole proprietorshipis owned by a

single individual.

A sole proprietorshipis owned by a

single individual.

A partnership isowned by two ormore individuals.

Partnerships requireclear agreements about

authority, risks, andthe sharing of profits

and losses.

A partnership isowned by two ormore individuals.

Partnerships requireclear agreements about

authority, risks, andthe sharing of profits

and losses.

A corporation is a separate legal entity

created by the authorityof a state government.

Each state hasseparate laws governingestablishing corporations.

A corporation is a separate legal entity

created by the authorityof a state government.

Each state hasseparate laws governingestablishing corporations.

Regulation

Few laws govern the operationsof proprietorships and partnerships.

Few laws govern the operationsof proprietorships and partnerships.

Corporations are subject to regulations.

Large, publicly traded corporationsare much more heavily regulated thansmaller closely held corporations.

SEC Acts of 1933 and 1934

Sarbanes-Oxley Act of 2002

Exchange listing requirements.

Corporations are subject to regulations.

Large, publicly traded corporationsare much more heavily regulated thansmaller closely held corporations.

SEC Acts of 1933 and 1934

Sarbanes-Oxley Act of 2002

Exchange listing requirements.

Corporate Advantages

Separate legal Entity

Limited liability of stockholders

Continuous life

Easily transferable ownership rights

Ability to raise capital

Corporate Disadvantages

Governmental regulation

Corporate double taxation

Corporate Advantages

Separate legal Entity

Limited liability of stockholders

Continuous life

Easily transferable ownership rights

Ability to raise capital

Corporate Disadvantages

Governmental regulation

Corporate double taxation

Comparing Corporations with Proprietorships and Partnerships

Vice President(Production)

V ice President(M arketing)

V ice President(F inance)

V ice President(Personnel)

President

B oard of D irectorsInternal (m anagers) andExternal (non-m anagers)

Stockholders(O w ners of voting shares)

Elected byshareholders

Appointedby directors

Corporate Management Structure

Appearance of Capital Structure in Financial Statements

The ownership interest (equity)in a business is composed of: Owner/investor contributions. Retained earnings.

The ownership interest (equity)in a business is composed of: Owner/investor contributions. Retained earnings.

Legal capital is the amount of capital, required by the state of incorporation, that

must remain invested in the business.

Par Value

Nominal Amount

Legal capital

Characteristics of Capital stock

Some states do not

require a par value to be

stated in the charter.

No-par Stock

Characteristics of Capital stock

Par value is an arbitrary amount assigned to each

share of stock when it is authorized.

Par value is an arbitrary amount assigned to each

share of stock when it is authorized.

Market price is the amount that each share of stock will

sell for in the market.

Market price is the amount that each share of stock will

sell for in the market.

Characteristics of Capital stock

Authorized, Issued, and Outstanding Capital Stock

The maximum number of shares of capital stock

that can be sold to the public.

Authorized

Shares

Authorized, Issued, and Outstanding Capital Stock

Issued shares

are authorized shares of stock

that have been sold.

Unissued shares are authorized shares of stock

that never have

been sold.

Authorized

Shares

Authorized, Issued, and Outstanding Capital Stock

Unissued

SharesTreasur

yShares

Outstanding

SharesIssuedShares

Treasury shares are issued shares that

have been reacquired by the

corporation.

Outstanding shares are issued shares that are owned by

stockholders.

Authorized

Shares

Corporations are not required to pay dividends, but once declared,

dividends are legal obligations.

Dividends

Stockholders

Cash Dividends

Corporation

Three important dates

Cash Dividends

Date of Record

No entryrequired.

Payment DateRecord payment of

cash to stockholders.

Declaration Date

Record liabilityfor dividend.

Dividends

Declaration Date

Declaration Date

Record liabilityfor dividend.

Dividends

On October 15, 2006, Nelson’s Board of Directors declared a cash dividend on

the 100 outstanding shares its 7 percent, $10 par preferred stock. The

dividend will be paid on December 15 to stockholders of record on November 15.

Let’s record the entries.

On October 15, 2006, Nelson’s Board of Directors declared a cash dividend on

the 100 outstanding shares its 7 percent, $10 par preferred stock. The

dividend will be paid on December 15 to stockholders of record on November 15.

Let’s record the entries.

Account Title Debit CreditDividends 70 Dividends Payable 70

0.07 × $10 par × 100 shares = $70

Date of Record

No entry required on November 15.

On October 15, 2006, Nelson’s Board of Directors declared a cash dividend on

the 100 outstanding shares its 7 percent, $10 par preferred stock. The

dividend will be paid on December 15 to stockholders of record on November 15.

Let’s record the entry

On October 15, 2006, Nelson’s Board of Directors declared a cash dividend on

the 100 outstanding shares its 7 percent, $10 par preferred stock. The

dividend will be paid on December 15 to stockholders of record on November 15.

Let’s record the entry

Date of Record

No entryrequired.

Payment DateOn October 15, 2006, Nelson’s Board of Directors declared a cash dividend on

the 100 outstanding shares its 7 percent, $10 par preferred stock. The

dividend will be paid on December 15 to stockholders of record on November 15.

Let’s record the entry

On October 15, 2006, Nelson’s Board of Directors declared a cash dividend on

the 100 outstanding shares its 7 percent, $10 par preferred stock. The

dividend will be paid on December 15 to stockholders of record on November 15.

Let’s record the entryPayment

DateRecord payment ofcash to stockholders.

Account Title Debit CreditDividends Payable 70 Cash 70

Stock Dividends

Distribution of additional sharesof stock to stockholders.

No change in total stockholders’ equity.

No change inpar values.

All stockholders retain same percentage ownership.

Stock Dividends

The journal entry moves an amount fromRetained Earnings to other equity accounts.The journal entry moves an amount from

Retained Earnings to other equity accounts.

Nelson’s Board of Directors decided to issue a 10 percent stock dividend on the 150 outstanding shares of its $20 par value, Class B common stock. Market value at the time of the stock dividend was $30 per

share. Let’s record the entry.

Nelson’s Board of Directors decided to issue a 10 percent stock dividend on the 150 outstanding shares of its $20 par value, Class B common stock. Market value at the time of the stock dividend was $30 per

share. Let’s record the entry.

Account Title Debit CreditRetained Earnings 450 Common Stock, Class B 300 Paid-in-Capital in Excess of Par, Class B 150

0.10 × 150 shares × $30 per share = $450

0.10 × 150 shares × $20 par = $300

Stock Splits Stock splits replace existing

shares with a greater number of new shares.

Companies use stock splits to reduce market price per share of their outstanding stock.

The number of outstanding shares increase and par value is decreased proportionately.

Retained earnings is not affected. (No entry is made at all!)

Stock splits replace existing shares with a greater number of new shares.

Companies use stock splits to reduce market price per share of their outstanding stock.

The number of outstanding shares increase and par value is decreased proportionately.

Retained earnings is not affected. (No entry is made at all!)

Stock Splits

Before Split

After Split

Common Stock Shares 165

Par Value per Share 20$

Total Par Value 3,300$

Nelson’s Board of Directors declared a 2-for-1 stock split on the 165 outstanding shares of its $20 par

value, Class B common stock.

Nelson’s Board of Directors declared a 2-for-1 stock split on the 165 outstanding shares of its $20 par

value, Class B common stock.

Stock Splits

Increase

Decrease

No Change

No journal entry required – Change par value and number of shares authorized and outstanding.

Before Split

After Split

Common Stock Shares 165 330

Par Value per Share 20$ 10$

Total Par Value 3,300$ 3,300$

Nelson’s Board of Directors declared a 2-for-1 stock split on the 165 outstanding shares of its $20 par

value, Class B common stock.

Nelson’s Board of Directors declared a 2-for-1 stock split on the 165 outstanding shares of its $20 par

value, Class B common stock.

No voting or

dividend rights

Contra equity

account

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

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

Treasury shares are

issued shares that have been reacquired

by the corporation.

Treasury shares are

issued shares that have been reacquired

by the corporation.

Treasury Stock

Why woulda company

buy itsown stock?

Why woulda company

buy itsown stock?

Treasury Stock

Common reasons include:

Employee stock option plans.

Preparation for a merger.

To increase earnings per share.

Supporting the stock price.

To avoid a hostile takeover.

Common reasons include:

Employee stock option plans.

Preparation for a merger.

To increase earnings per share.

Supporting the stock price.

To avoid a hostile takeover.

Treasury Stock

Account Title Debit CreditTreasury Stock 1,000 Cash 1,000

50 shares × $20 per share = $1,000

Assume that Nelson paid $20 per share to buyback 50 shares of the $10 par value stock thatit originally issued at a price of $22 per share.

Let’s record this transaction.

Assume that Nelson paid $20 per share to buyback 50 shares of the $10 par value stock thatit originally issued at a price of $22 per share.

Let’s record this transaction.

Treasury Stock

Account Title Debit CreditCash 750 Treasury Stock 600 Paid-in-Capital in Excess of Cost of Tr. Stk. 150

30 shares × $25 per share = $750

Assume Nelson resells 30 shares of its treasurystock at a price of $25 per share.

Let’s record this transaction.

Assume Nelson resells 30 shares of its treasurystock at a price of $25 per share.

Let’s record this transaction.

30 shares × $20 cost = $600

No gain or loss is recognized on sale of treasury stock.

The Financial Analyst

DividendsIncrease in market

price per share

Stockholders benefit in two wayswhen a company generates

earnings.

Price-Earnings Ratio

Selling price of one share of stock Earnings per share*

This ratio is used by analysts to evaluate the future prospects of a company.The higher the PE ratio, the more optimistic investors are about a company’s future.

* Earnings per share = net income - preferred dividends divided by the weighted average number of common shares of outstanding stock.

Class Assignments

Questions #8, 10, 15, 30, 32 (page 536)

Chapter 11