©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