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STOCKHOLDERS’ EQUITY:

Chapter

11

2

Existence is separate from

owners.

Existence is separate from

owners.

An entity created by law.

An entity created by law.

Has rights and privileges.

Has rights and privileges.

Privately, or Closely, Held

Publicly Held

Ownership can be

CorporationsCorporations

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Limited personal liability for

stockholders.

Limited personal liability for

stockholders.

Transferability of ownership.

Transferability of ownership.

Professional management.

Professional management.

Continuity of existence.

Continuity of existence.

Advantages of IncorporationAdvantages of Incorporation

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Heavy taxation.Heavy taxation.

Greater regulation.Greater regulation.

Cost of formation.Cost of formation.

Separation of ownership and management.

Separation of ownership and management.

Disadvantages of IncorporationDisadvantages of Incorporation

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Stockholders

Rights

Voting (in person or by proxy).

Proportionate distribution of

dividends.

Proportionate distribution of

assets in a liquidation.

Rights of StockholdersRights of Stockholders

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C orpora te O rgan iza tion C hart

Secreta ry T rea surer C ontro ller O ther V icePresidents

President

B oa rd of D irectors

StockholdersUltimate control

Ultimate control

Stockholders usually meet once a year.

Stockholders usually meet once a year.

Stockholder ledgers are often maintained by a stock transfer agent or stock

registrar.

Stockholder ledgers are often maintained by a stock transfer agent or stock

registrar.

Rights of StockholdersRights of Stockholders

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Each unit of ownership is

called a share of stock.

A stock certificate serves

as proof that a stockholder has

purchased shares.

Rights of StockholdersRights of Stockholders

8

When the stock is sold, the stockholder

signs a transfer endorsement on the back of the

stock certificate.

Rights of StockholdersRights of Stockholders

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C orpora te O rgan iza tion C hart

Secreta ry T rea surer C ontro ller O ther V icePresidents

President

B oa rd of D irectors

StockholdersOverall

responsibility for managing the company.

Overall responsibility for managing the company.

Selected by a vote of the

stockholders

Selected by a vote of the

stockholders

Functions of the Board of DirectorsFunctions of the Board of Directors

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C orpora te O rgan iza tion C hart

Secreta ry T rea surer C ontro ller O ther V icePresidents

President

B oa rd of D irectors

Stockholders

Chief Accountant

Chief Accountant

Contractual and legal representation

Contractual and legal representation

Custodian of funds

Custodian of funds

Functions of the Corporate OfficersFunctions of the Corporate Officers

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Paid-in Capita l

Contributions byinvestors in exchange

for capital stock.

Retained Earnings

Retention of profitsearned by thecorporation.

Stockholders' equity isincreased in tw o w ays.

Paid-In Capital of a CorporationPaid-In Capital of a Corporation

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The maximum number of

shares of capital stock that can be

sold to the public.

AuthorizedShares

AuthorizedShares

Authorization and Issuance of Capital Stock

Authorization and Issuance of Capital Stock

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Issued shares are authorized shares of stock that have been

sold.

Unissued shares are authorized shares of stock that

never have been sold.

Usually shares are

sold through an

underwriter.

Usually shares are

sold through an

underwriter.

AuthorizedShares

AuthorizedShares

Authorization and Issuance of Capital Stock

Authorization and Issuance of Capital Stock

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UnissuedShares

TreasuryShares

OutstandingShares

Treasury shares are issued shares that

have been reacquired by the corporation.

IssuedShares

IssuedShares

Outstanding shares are issued shares that are

owned by stockholders.

AuthorizedShares

AuthorizedShares

Authorization and Issuance of Capital Stock

Authorization and Issuance of Capital Stock

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Par value is an Par value is an arbitrary arbitrary amount amount

assigned to assigned to each share of each share of

stock when it is stock when it is authorized.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.

Stockholders’ EquityStockholders’ Equity

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Common stock can be issued in two forms:Common stock can be issued in two forms:

No-Par Common

Stock

No-Par Common

Stock

Par Value Common

Stock

Par Value Common

Stock

Let’s examine this form of

stock.

Let’s examine this form of

stock.

All proceeds credited to

Common Stock

All proceeds credited to

Common Stock

Stockholders’ EquityStockholders’ Equity

Existin

g Com

pany’

s Act

New C

ompan

y’s A

ct

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Prepare the journal entry to record an issuance of 10,000 shares of $2 par value stock for $25

per share which occurred on September 1, 2003.

Prepare the journal entry to record an issuance of 10,000 shares of $2 par value stock for $25

per share which occurred on September 1, 2003.

Record:

The cash received.

The number of shares issued × the par value per share in the Common Stock account.

The remainder is assigned to Contributed Capital in Excess of Par/Share Premium

Record:

The cash received.

The number of shares issued × the par value per share in the Common Stock account.

The remainder is assigned to Contributed Capital in Excess of Par/Share Premium

Issuance of Par Value StockIssuance of Par Value Stock

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The journal entry to record an issuance of 10,000 shares of $2 par value stock for $25 per share on

September 1, 2003, should include a credit to common stock for the par value of the shares

issued.

The journal entry to record an issuance of 10,000 shares of $2 par value stock for $25 per share on

September 1, 2003, should include a credit to common stock for the par value of the shares

issued.

Issuance of Par Value StockIssuance of Par Value Stock

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Issuance of Par Value StockIssuance of Par Value Stock

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A separate class of stock, typically having priority over common shares in . . .

Dividend distributions (rate is usually stated). Distribution of assets in case of liquidation.

A separate class of stock, typically having priority over common shares in . . .

Dividend distributions (rate is usually stated). Distribution of assets in case of liquidation.

Cumulative dividend rights.

Cumulative dividend rights.

Normally has no voting

rights.

Normally has no voting

rights.

Usually callable by

the company.

Usually callable by

the company.

Other Features Include:

Preferred StockPreferred Stock

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Vs. NoncumulativeCumulative

Dividends in arrears must be

paid before dividends may be paid on common

stock.

Dividends in arrears must be

paid before dividends may be paid on common

stock.

Undeclared dividends from

current and prior years do not have to be paid in future

years.

Undeclared dividends from

current and prior years do not have to be paid in future

years.

Cumulative Preferred StockCumulative Preferred Stock

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Example: Consider the following partial Statement of Stockholders’ Equity.

During 2002, the directors declare cash dividends of $5,000. In year 2003, the directors declare cash

dividends of $42,000.

Stock Preferred as to DividendsStock Preferred as to Dividends

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Example: Consider the following partial Statement of Stockholders’ Equity.

During 2000, the directors declare cash dividends of $5,000. In year 2001, the directors declare cash

dividends of $42,000.

Stock Preferred as to DividendsStock Preferred as to Dividends

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I just converted 100 shares of preferred stock

into 1,000 shares of common stock and ended up with a higher dividend

yield!

I just converted 100 shares of preferred stock

into 1,000 shares of common stock and ended up with a higher dividend

yield!

Gee, I can’t do that with MYMY preferred

stock!

Gee, I can’t do that with MYMY preferred

stock!

Some preferred stock is convertible

into shares of common stock.

Convertible Preferred StockConvertible Preferred Stock

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Preferred StockPreferred Stock

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Companies sometimes issue stock in exchange for non-

cash assets.

Companies sometimes issue stock in exchange for non-

cash assets.

Since no cash is received, record the transaction at the market value of the goods or

services received.

Since no cash is received, record the transaction at the market value of the goods or

services received.

Stock Issued for Assets Other Than Cash

Stock Issued for Assets Other Than Cash

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I love this stuff!

Can we do some more?

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Accounting by the issuer.

Accounting by the issuer.

Accounting by the investor.

Accounting by the investor.

Common stock is carried at original issue

price.

Common stock is carried at original issue

price.

Investments in marketable securities are carried at market

value.

Investments in marketable securities are carried at market

value.

Market ValueMarket Value

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Factors affecting market price of preferred stock:

Dividend rate Risk Level of interest rates

Factors affecting market price of preferred stock:

Dividend rate Risk Level of interest rates

The return based on the market value is called the “dividend

yield.”

The return based on the market value is called the “dividend

yield.”

Market Price of Preferred StockMarket Price of Preferred Stock

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Factors affecting market price of common stock:

Investors’ expectations of future profitability.

Risk that this level of profitability will not be achieved.

Factors affecting market price of common stock:

Investors’ expectations of future profitability.

Risk that this level of profitability will not be achieved.

Changes in market value have no impact on the

books of the issuer.

Changes in market value have no impact on the

books of the issuer.

Market Price of Common StockMarket Price of Common Stock

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Ice Cream Parlor

Banana Splits On Sale Now

Stock SplitsStock Splits

Companies use stock splits to reduce market price.

Outstanding shares increase, but par value is decreased proportionately.

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Assume that a corporation had 5,000 shares of $1 par value common stock outstanding

before a 2–for–1 stock split.

Increase

Decrease

No Change

Stock Splits - ExampleStock Splits - Example

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Stock DividendsStock Dividends

A company may be short of cash and be unable to pay a cash dividend. A stock dividend is a distribution by a corporation of its own stock to its shareholders.

Stock dividends Affect only stockholders equity accounts i.e. RE & Common

Stock Have no effect on total stockholders equity.

Stock dividends to be distributed to stockholders are proportionate to the number of shares they already own. Example. Suppose you own 300 shares of common stock. The company distributes a 10% stock dividend. You would now receive 30 additional shares and would now have 330 shares but you would be in the same position as before in terms of percentage ownership.

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Recording Stock DividendsRecording Stock Dividends

Stock dividends are issued - To continue dividends but conserve on cash for

investment purposes - To reduce the market price of its stock so as to

make it more attractive to investors.

Dr Retained Earnings (MV of shares)Cr Common Stock (Par value)Cr Paid-in Capital in Excess of Par

Note that a stock dividend merely rearranges the Stockholders equity section of the BS.

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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 StockTreasury Stock

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On May 1, 2003, East Corp. reacquired 3,000 shares of its common stock at $55 per share.

Prepare the journal entry for May 1.

Treasury Stock - ExampleTreasury Stock - Example

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On December 3, 2003, East Corp. reissued 1,000 shares of the stock at $75 per share.

Prepare the journal entry for December 3.

1,000 shares × $75 = $75,0001,000 shares × $75 = $75,000

1,000 shares × $55 cost = $55,0001,000 shares × $55 cost = $55,000

Treasury Stock - ExampleTreasury Stock - Example

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Stockholders’ Equity - PresentationStockholders’ Equity - Presentation

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Statement of Changes in Equity – Presentation as per IAS1

Statement of Changes in Equity – Presentation as per IAS1

•Assume that the Stockholder’s Equity information on slide 38 was as at December 31. 2003 and that for 2004 the following occurred:

•Net income after tax was $30,000

•Issued 10,000 shares of common stock with a par value of $10 for $15

•Paid cash dividends of $5,000 for preference stock and $2000 for common stock.

•Issued stock dividend of 1,000 shares of common stock with a par value of $10. The FMV was also $10

Required: Prepare a statement of changes in equity for the year ended December 31, 2004 (Solution presented in class)

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This isn’t what I meant when I asked

for stock for my birthday!

End of Chapter 11End of Chapter 11