Chapter 15. Learning Objectives. Stockholders Equity. Learning Objective 1, 2. Proprietorship. Forms of Ownership. Stockholders Equity

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1 Chapter 15 Learning Objectives 1. Discuss corporate form of organization 2. Identify key components of stockholders equity 3. Explain accounting for issuing shares of stock 4. Describe accounting for treasury stock 5. Explain accounting and reporting of preferred stock 6. Describe policies used in distributing dividends 7. Identify various forms of dividend distributions 8. Explain small, large stock dividends, share splits 9. How to present and analyze stockholders equity 10. Appendix: Additional preferred stock calculations Annual reports: Chipotle, Whole Foods 1 2 Learning Objective 1, 2 Corporate Form " Corporate law " Capital stock or share system " Variety of ownership interests Equity " Issuance of stock " Reacquisition of shares Preferred Stock " Features " Accounting for and reporting preferred stock Dividend Policy " Financial condition and dividend distributions " Types of dividends " Stock split Presentation and Analysis " Presentation " Analysis Discuss the characteristics of the corporate form of organization Identify the key components of stockholders equity " Disclosure of restrictions 3 4 Forms of Ownership Three forms of business ownership Proprietorship Partnership Corporation Proprietorship Single owner Net income belongs to one owner Owner personally liable for all business s debts 5 1

2 Partnership Two or more parties are co-owners Formula to allocate profits to partners Unlimited liability Each partner personally liable for debt Mutual agency When any partner enters into contract all partners personally liable for debt Limited-Liability Co. (LLC) Limited-Liability Partner. (LLP) May have one owner or many owners Formula to allocate profits to owners Owners have limited liability No personal liability No mutual agency Liability limited to investment in business Corporation Many owners Owners called stockholders Stockholders share equally Stock represents % ownership Advantages of Corporation Ease of raising capital Ease of transferring ownership Continuous life Limited liability of stockholders 9 10 Stockholders Rights Vote Elect board of directors Issues at annual meeting Dividends Receive share of net income Liquidation Receive assets after liabilities paid in full Preemption Maintain % when new stock issued 11 Board of Directors Sets goals, policies of company Measures performance of management Hires executive officers CEO (chief executive officer) CFO (chief financial officer) CTO (chief technical officer) 12 2

3 State Corporate Law Submits articles of incorporation to state Accounting for stockholder s equity follows state law Where are they incorporated? Hewlett-Packard: Delaware Google: Delaware Facebook: Delaware Learning Objective 3 Explain the accounting procedures for issuing shares of stock Shares of Stock Paid-in capital Cash from investors, sale of stock Also called Contributed capital Retained earnings Authorized Issued Treasury Outstanding Number of Shares Maximum shares that can be issued Shares sold to public Shares issued and repurchased = Issued Treasury

4 19 20 Issuance of Stock Par value stock No-par stock Stated value stock Par Value Arbitrary amount assigned to stock Legal capital Must remain invested in corporation Cannot be paid as dividends ISSUE STOCK AT PAR ISSUING STOCK Issue Stock at Par Issue price $10 Par value $10 Shares issued 3,200,000 Issue price > par value Two paid-in capital accounts Common stock, at par value Additional paid-in capital [Add. PIC] Cash (3,200,000 $10) 32,000,000 Common Stock (3.2M $10) 32,000,000 Issued 3,200,000 shares of common stock at $10 par

5 ISSUED ABOVE PAR PAID-IN CAPITAL Issue Stock Above Par Value Issue price $10.00 Par value $ 0.01 Shares issued 3,200,000 Cash (3,200,000 $10) 32,000,000 Common Stock (3.2M $0.01) 32,000 Additional Paid-In Capital Plug 31,968,000 Issued 3,200,000 shares of $0.01 par common stock at $10 par 25 Cash received when stock first sold Amount invested by stockholders Calculation of Total Paid-In Capital Common stock (par value) 32,000 + Additional paid-in capital 31,968,000 Total paid-in capital 32,000, STOCKHOLDERS EQUITY ISSUING STOCK Common stock, $0.01 par, 40 million shares authorized, 3.2 million issued $ 32,000 Additional Paid-In Capital 31,968,000 Total Paid-In Capital 32,000,000 Retained Earnings 26,000,000 Total $58,000,000 No profit (loss) incurs when stock Originally sold to public Repurchased, resold to public No stock transaction ever results in Revenue Gain Expense Loss Brief exercise 1 WileyPLUS NO-PAR STOCK Does not have a par value May have stated value (similar to par) Some states count total issue price for no-par stock as legal capital, which reduces flexibility in paying dividends

6 ISSUING NO-PAR STOCK STOCKHOLDERS EQUITY Issue No Par Common Stock Issue price $20 Shares issued 3,000 Cash (3,000 $20) 60,000 Common Stock 60,000 Issued 3,000 shares of $20 no-par common stock Common stock, no-par, 10,000 shares authorized, 3,000 issued $ 60,000 Retained Earnings 46,000 Total $106,000 No Additional Paid-In Capital account No Par Stated Value Some states require no-par stock to have stated value JE calculation treats stated value as par Brief exercise 2 WileyPLUS Cash 15,000 Common stock (1,000 $5) 5,000 PIC in excess of stated value Plug 10,000 Issued 1,000 shares with $5 stated value at $15 per share Three Cases Stock issued in combination (bundle) Stock issued in noncash transactions Costs of issuing stock Common Stock Issued with Other Securities Usually each type of stock (common, preferred) sold separately Sometimes common and preferred sold together in a bundle Two methods of allocating proceeds Proportional method Incremental method

7 Common Stock Issued with Other Securities Proportional method Allocated by relative FMV Incremental method Allocate to one security based on FMV, remainder allocated to other security 37 Proportional Method Cash Received Cash $13,500 Common Stock Market value per share $20 Par value $10 Shares issued 300 Preferred Stock Market value per share $90 Par value $50 Shares issued Proportional Method Number Market Value Total Percent Common shares 300 x $ = $ 6,000 40% Preferred shares 100 x ,000 60% Fair Market Value $ 15, % Number Market Value Total Percent Common shares 300 x $ = $ 6,000 40% Preferred shares 100 x ,000 60% Fair Market Value $ 15, % Allocation: Common Preferred Issue price $ 13,500 $ 13,500 Allocation % 40% 60% Total $ 5,400 $ 8,100 Allocation: Common Preferred Issue price $ 13,500 $ 13,500 Allocation % 40% 60% Total $ 5,400 $ 8, Cash 13,500 Preferred Stock (100 $50) 5,000 PIC In Excess of Par Preferred Plug 3,100 Common Stock (300 $10) 3,000 PIC In Excess of Par Common Plug 2, Incremental Method Incremental Method Cash Received Cash $13,500 Common Stock Market value per share $20 Par value $10 Shares issued 300 Preferred Stock Market value per share Unknown Par value $50 Shares issued Number Amount Total Common shares 300 x $ = $ 6,000 Preferred shares 100 x - Fair Market Value $ 6,000 Allocation: Common Preferred Issue price $ 13,500 Ordinary (6,000) Total $ 6,000 $ 7,

8 Number Amount Total Common shares 300 x $ = $ 6,000 Preferred shares 100 x - Fair Market Value $ 6,000 Allocation: Common Preferred Issue price $ 13,500 Ordinary (6,000) Total $ 6,000 $ 7,500 Brief exercise 4 WileyPLUS Cash 13,500 Preferred stock (100 $50) 5,000 PIC in excess of par preferred Plug 2,500 Common stock (300 $10) 3,000 PIC in excess of par common Plug 3, Stock Issued in Noncash Transactions Use value more clearly determinable Fair value of stock given Fair value of noncash consideration received (goods or services) Example 1: Stock Issued in Noncash Transactions Issue Common Stock in Exchange for Patent Par common stock value $10 Shares common stock issued 10,000 FMV common stock $140,000 FMV patent Unknown 45 Patent 140,000 Common stock (10,000 $10) 100,000 Paid-in capital in excess of par Plug 40,000 Issued 10,000 shares, $10 par, FMV $140,000, in exchange for patent 46 Example 2: Stock Issued in Noncash Transactions Issue Common Stock in Exchange for Patent Par common stock value $10 Shares common stock issued 10,000 FMV common stock Unknown FMV patent $150,000 Patent 150,000 Common stock (10,000 $10) 100,000 Paid-in capital in excess of par Plug 50,000 Issued 10,000 shares with $10 par value for patent with FMV $150, Example 3: Stock Issued in Noncash Transactions Issue Common Stock in Exchange for Patent Par common stock value $10 Shares common stock issued 10,000 FMV common stock FMV patent Unknown Unknown PV of future cash flows from patent $125,000 Patent 125,000 Common stock (10,000 $10) 100,000 Paid-in capital in excess of par Plug 25,000 Issued 10,000 shares with $10 par value for patent valued at $125,

9 Costs of Issuing Stock Direct costs incurred to sell stock Underwriting costs Accounting and legal fees Printing costs Taxes Do not record expense Stock transactions never impact N/I Reduction to PIC in Excess of Par 49 Costs of Issuing Stock Common Stock with Issuing Costs Issue price $ 50 Par value $ 1 Shares issued 5,000 Legal, accounting, filing fees $10,000 Cash [(5,000 $50) 10,000] 240,000 Common stock (5,000 $1) 5,000 Paid-in capital in excess of par Plug 235,000 Issued 5,000 shares, $1 par value, at $50, issue costs $10, WileyPLUS Brief exercises 5, 6 Learning Objective 4 Describe accounting for treasury stock TREASURY STOCK Purchase stock already issued Stock held in treasury Receive no dividends Do not vote As if never issued WALL STREET JOURNAL

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11 61 62 WHY TREASURY STOCK? WHY TREASURY STOCK? Increase stock price Reward shareholders by returning cash Tax-efficient distribution of excess cash Need stock for employee stock compensation Need stock for potential merger Temporary stock price decline 63 To increase stock price Increase earnings per share (EPS) Increase dividends per share Earnings per share = Dividends per share = Net income Average shares outstanding Total dividends paid Average shares outstanding 64 PURCHASE, SELL T-STOCK Two Methods Before purchase Assets $17 Liabilities $10 Stockholders Equity $7 Treasury stock for $4 billion Assets $13 Liabilities $10 Stockholders Equity $3 Sold treasury stock for $7 billion Assets $20 Liabilities $10 Stockholders Equity $10 Cost method (more widely used) Recorded at cost, without reference to par value or original issue price Par value method (rarely used) Recorded at par value

12 TREASURY STOCK TREASURY STOCK (Before Purchase of Treasury Stock) Common stock, $1 par, 10,000 shares authorized, 8,000 shares issued $ 8,000 Additional Paid-In Capital 12,000 Retained Earnings 40,000 Total $ 60,000 Treasury stock has debit balance Recorded at cost, without reference to par value or original issue price Treasury Stock (1,000 $5) 5,000 Cash 5,000 Purchase 1,000 shares for treasury at $5 per share TREASURY STOCK TREASURY STOCK Treasury Stock like contra-account in stockholders equity Treasury Stock + Beginning balance 0 Purchases at cost 5,000 Sales at cost Ending balance 5,000 Calculation of Shares Outstanding Shares issued 8,000 Shares in treasury 1,000 Shares outstanding 7, TREASURY STOCK Sale of Treasury Stock (After Purchase of Treasury Stock) Common stock, $1 par, 10,000 shares authorized, 8,000 shares issued $ 8,000 Additional Paid-In Capital 12,000 Retained Earnings 40,000 Subtotal 60,000 Treasury Stock, 1,000 shares (5,000) Total $ 55,000 Above cost Below cost

13 Sale of Treasury Stock Treasury stock purchased and sold No gains, losses, revenue or expense No change in net income Increases assets and equity Sale of Treasury Stock Selling price > purchase cost Increase Add. Paid-In Capital Treas-Stock Selling price < purchase cost Decrease Add. Paid-In Capital Treas-Stock Decrease Retained Earnings Example 1: Treasury Stock Sold Above Cost Sale of Treasury Stock Shares of treasury stock sold 200 Selling price $ 9 Purchase cost $ 5 Cash (200 $9) 1,800 Treasury Stock (200 $5) 1,000 Additional Paid-In Cap: T-Stock Plug 800 Sold 200 shares of treasury stock at $9 per share, purchase cost $5 75 Treasury Stock + Beginning balance 0 Purchases at cost 5,000 1,000 Sales at cost Ending balance 4,000 Additional Paid-In Capital, Treasury Stock + 0 Beginning balance 800 Sale of T-stock 800 Ending balance 76 TREASURY STOCK Example 2: Treasury Stock Sold Below Cost (After Sale of Treasury Stock) Common stock, $1 par, 10,000 shares authorized, 8,000 shares issued $ 8,000 Additional Paid-In Capital (12, ) 12,800 Retained Earnings 40,000 Subtotal 60,800 Treasury Stock, 800 shares (4,000) Total $ 56, Sale of Treasury Stock Shares of treasury stock sold 100 Selling price $ 4 Purchase cost $ 5 Cash (100 $4) 400 Additional PIC: T-Stock Plug 100 Treasury Stock (100 $5) 500 Sold 100 shares of treasury stock at $4 per share, purchase cost $

14 Treasury Stock + Beginning balance 0 Purchases at cost 5,000 1,000 Sales at cost 500 Sales at cost Ending balance 3,500 Additional Paid-In Capital, Treasury Stock + 0 Beginning balance Sale of T-stock Sale of T-stock 700 Ending balance 79 Example 3: Treasury Stock Sold Below Cost Sale of Treasury Stock Shares of treasury stock sold 500 Selling price $ 3 Purchase cost $ 5 Cash (500 $3) 1,500 Additional Paid-In Cap: T-Stock 700 Retained Earnings Plug 300 Treasury Stock (500 $5) 2,500 Sold 500 shares of treasury stock at $3 per share, purchase cost $5 80 Treasury Stock + Beginning balance 0 Purchases at cost 5,000 1,000 Sales at cost 500 Sales at cost 2,500 Sales at cost Ending balance 1,000 Retiring Treasury Stock Cancellation of treasury stock Reduction in number of shares issued Additional Paid-In Capital, Treasury Stock + 0 Beginning balance Sale of T-stock Sale of T-stock Sale of T-stock Ending balance WileyPLUS Learning Objective 5 Brief exercises 3, 7, 8 Preferred stock

15 PREFERRED STOCK Hybrid security (common stock, bond) Non-voting Paid before common stock Cash dividends In liquidation Issued primarily by Banks, insurance companies Older corporations AMOUNT OF DIVIDEND Stated as dollar amount, $3.00 Stated as percentage of par value Par value, $100 Stated rate, 6% Dividend amount, $6.00 PREFERRED DIVIDENDS Dividends must be declared by Board Usually paid in full May not be declared if no cash available PREFERRED STOCK STOCKHOLDERS EQUITY Issue Preferred Stock Par value $ 50 Issue price $ 80 Shares issued 1,000 Cash (1,000 $80) 80,000 Preferred Stock (1,000 $50) 50,000 Additional Paid-In Cap: Preferred Plug 30,000 Issued 1,000 shares of $50 par preferred stock at $80 per share 89 Preferred stock, $50 par, 6%, 50,000 shares authorized, 1,000 shares issued $ 50,000 Additional Paid-In Capital: Preferred 30,000 Common stock, $1 par, 10,000 shares authorized, 8,000 shares issued 8,000 Additional Paid-In Capital: Common 12,000 Retained Earnings 40,000 Total $ 140,

16 PREFERRED STOCK PREFERRED STOCK Can be issued with conversion feature Allows preferred shareholders to exchange preferred shares for common Cash (1,000 $60) 60,000 Convertible Preferred Stock 60,000 Issued 1,000 shares of convertible preferred stock at par, $60 per share Cash (1,000 $60) 60,000 Convertible Preferred Stock 60,000 Issued 1,000 shares of convertible preferred stock at par, $60 per share 91 Convertible Preferred Stock 60,000 Common Stock (1,000 5 $1) 5,000 Additional Paid-In Capital Plug 55,000 Converted 1,000 preferred stock to $1 par common stock Conversion rate: 1 share preferred stock = 5 shares common stock 92 Preferred Stock: Possible Features Convertible (into common stock) Participating (more than stated div) Redeemable (maturity date) Callable (at option of corporation) 93 Legal obligation to repay principal Comparison Common Stock Dividends / interest Dividends, not tax deductible Obligation to pay dividends / interest Preferred Stock Long-Term Debt Never repaid Never repaid Yes, legal obligation No legal obligation Dividends, not tax deductible No legal obligation Risk to issuer None None High Interest exp, tax deductible Buyer risk Highest Moderate Lowest Buyer reward Highest Moderate Lowest Yes, amount and dates fixed 94 Brief exercise 9 WileyPLUS Learning Objective 6 Dividend policies

17 Retained Earnings Net income over lifetime of business not paid out as dividends Not a reservoir of cash Source of equity financing Purchase assets Pay liabilities Research and development Why Not Pay All Net Income as Dividends? Finance growth or expansion Smooth out dividend payments Cushion against possible losses Maintain agreements with creditors Learning Objective 7 Forms of dividend distributions Types of Dividends Cash dividends Property dividends Liquidating dividends Stock dividends Cash Dividends Board of directors vote to declare Declared dividend is a liability All dividends, except stock dividends, reduce total stockholders equity

18 Dividend Dates CASH DIVIDENDS Date Description JE Declaration Board declares dividend Record Holders on date receive dividend Payment Dividend paid Retained Earnings 50,000 Dividends Payable 50,000 Cash dividend declared, $50,000 No journal entry on date of record 103 Dividends Payable 50,000 Cash 50,000 Cash dividend paid, $50, Retained Earnings Property Dividends Retained Earnings + 100,000 Beginning balance Cash dividends 50,000 80,000 Net income 130,000 Ending balance Dividends paid in non-cash assets Distribution of investments Debt or equity of other companies Declaration date: Restate property at fair value, record gain (loss) Privately held corporation, few shareholders, give dividend to owners without using cash Property Dividends Investments (Assets) Transferred to Stockholders Cost of investments $ 125,000 FMV of investments $ 200,000 Calculation of Gain (Loss) FMV of investments $200,000 Cost of investments 125,000 Gain (loss) $75,000 Calculation of Gain (Loss) FMV of investments $200,000 Cost of investments 125,000 Gain (loss) $75,000 Investments 75,000 Gain on Investments 75,000 Declaration date: Adjust Investments to FMV, record gain (loss) Retained Earnings 200,000 Property Dividends Payable 200,000 Declaration date: Reduce Retained Earnings, create liability

19 Property Dividends: Date of Property Distribution Retained Earnings 200,000 Property Dividends Payable 200,000 Declaration date: Reduce Retained Earnings, create liability Property Dividends Payable 200,000 Investments 200,000 Payment date: Investments distributed to stockholders of record Liquidating Dividends Retained Earnings balance negative Dividend amount > Retained Earnings Reduce any positive Retained Earnings Reduce Additional Paid-In Capital Liquidating Dividends: Date of Declaration Liquidating Dividend Cash dividend declared $ 120,000 Retained Earnings balance $ 90,000 Additional Paid-In Capital balance $ 800,000 WileyPLUS Brief exercises 10, 12 Retained Earnings 90,000 Paid-in Capital in Excess of Par 30,000 Dividends Payable 120,000 Declare cash dividends, $120,000; Retained Earnings balance, $90, Learning Objective 8 Explain accounting for small and large stock dividends, and for stock splits Why Stock Dividends, Splits Increase shares outstanding to Reduce market price of stock

20 Increase Shares Outstanding: Three Methods Type % Stock Outstanding Value Small dividend Less 20 25% Market Large dividend More 20 25% Par Split Not applicable STOCK DIVIDENDS, SPLITS Distribution of stock to shareholders Proportionally Own 10% of stock Receive 10% of shares distributed Small Stock Dividend Small Stock Dividend Market price of stock $16 Shares outstanding 20,000 Stock dividend rate 10% Shares Market price = Market value of company Shares Price Value Before 20,000 $16.00 $320,000 After 22,000 $14.55 $320,000 Small Stock Dividend Journal entry Decrease R/E at market value of stock Increase common stock at par value Increase additional paid-in capital No change is total equity No cash transferred to stockholders Small Stock Dividend Small Stock Dividend (Before Stock Dividend) Common stock, $10 par, 50,000 shares authorized, 20,000 shares issued $ 200,000 Additional Paid-In Capital 70,000 Retained Earnings 80,000 Total $ 350, Small Stock Dividend Par value $10 Market value $16 Shares outstanding 20,000 Stock dividend rate 10% Retained Earnings (20,000 10% $16) 32,000 Common Stock (20,000 10% $10) 20,000 Additional Paid-In Capital Plug 12,000 Issued 10% stock dividend (small), market value $16, par value $

21 Small Stock Dividend (After Stock Dividend) Common stock, $10 par, 50,000 shares authorized, 22,000 shares issued $ 220,000 Additional Paid-In Capital 82,000 Retained Earnings 48,000 Total $ 350, (Before Stock Dividend) Common stock, $10 par, 50,000 shares authorized, 20,000 shares issued $ 200,000 Additional Paid-In Capital 70,000 Retained Earnings 80,000 Total $ 350,000 (After Stock Dividend) Common stock, $10 par, 50,000 shares authorized, 22,000 shares issued $ 220,000 Additional Paid-In Capital 82,000 Retained Earnings 48,000 Total $ 350, Large Stock Dividend Large Stock Dividend Journal entry Decrease R/E at par value of stock Increase common stock at par value No change in additional paid-in capital Large Stock Dividend Par value $10 Shares outstanding 20,000 Stock dividend rate 40% Retained Earnings (20,000 40% $10) 80,000 Common Stock 80,000 Issued 40% stock dividend (large), par value $ Stock Splits Yahoo Finance: INTC Historical Prices Increase Shares authorized Shares issued Shares outstanding Decrease Par value

22 4:1 Stock Split Before After Stock price $100 $25 Par value before split $5.00 $1.25 Shares issued before split 140 M 560 M Shares Market price = Market value of company Shares Price Value 140 M $ $14,000 M 560 M $25.00 $14,000 M (Before 4:1 Stock Split) Common stock, $5 par 200 million authorized, 140 million issued $ 700 Additional Paid-In Capital 12,300 Retained Earnings 20,000 Total $ 33,000 (After 4:1 Stock Split) Common stock, $1.25 par, 800 million authorized, 560 million issued $ 700 Additional Paid-In Capital 12,300 Retained Earnings 20,000 Total $ 33, Stock Splits No journal entry, Memo only Called in the outstanding $5 par common stock and distributed four shares of $1.25 par common stock for each share outstanding Memo only: 4 for 1 stock split 130 STOCK DIVIDENDS, SPLITS Both increase issued, outstanding Both decrease market price of stock Stock dividend R/E È and paid-in capital Ç No change to par value, authorized Stock split No change to R/E and paid-in capital Par value È and shares authorized Ç 131 WileyPLUS Brief exercises 13,

23 Learning Objective 9 Indicate how to present and analyze stockholders equity Statement of Ratio Analysis Ratio Analysis Ratio Analysis

24 LO 10: Appendix Explain different types of preferred stock dividends and their effect on book value per share Omit participating preferred stock Dividend Preferences Distribute $50,000 cash dividends Common stock par value, $400,000 Preferred stock 6%, par value $100,000 Preferred stock noncumulative and nonparticipating Dividend Preferences Distribute $50,000 cash dividends Common stock par value, $400,000 Preferred stock 6%, par value $100,000 Preferred stock is cumulative and non-participating, and Mason Company did not pay dividends on preferred stock in preceding two years Book Value Per Share Net assets/common shares outstanding Preferred stock reduces R/E by Preferred dividends in arrears Preferred stock participating amount Excess of redemption value > book value Book Value Per Share End of Chapter No dividends in arrears No participating amount Redemption value < book value No reduction to retained earnings

25 Distribute $50,000 cash dividends Common stock par value, $400,000 Preferred stock 6%, par value $100,000 Preferred stock is noncumulative, fully participating Dividend Preferences Distribute $50,000 cash dividends Common stock par value, $400,000 Preferred stock 6%, par value $100,000 Preferred stock is cumulative and fully participating, did not pay dividends on preferred stock in past two years Preferred 5%, cumulative Three years preferred div in arrears Preferred participating, up to 8% Dividends not yet declared for period Calculation of retained earnings used in book value per common share calculation Retained earnings $162,582 Preferred stock Less dividends in arrears (45,000) Less current dividend at 5% (15,000) Less participating at 3% (9,000) Common stock Less current year at 5% (20,000) Less participating at 3% (12,000) Retained earnings available $61,582 See next page