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Spiceland Chapter 18Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.   
Shareholders’ Equity
Learning Objectives
Describe the components of shareholders’ equity and explain how they are reported in a statement of shareholders’ equity.
Our first learning objective in Chapter 18 is to describe the components of shareholders’ equity and explain how they are reported in a statement of shareholders’ equity.
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Assets – Liabilities = Shareholders’ Equity
Net Assets
(Residual Interest)
Shareholders’ equity accounts represent the ownership interests of the shareholders in a corporation. From the balance sheet, total shareholders’ equity equals total assets minus total liabilities. Another way to think about shareholders’ equity is that it represents the portion of a corporation’s assets that have been financed by the owners as opposed to that portion that has been financed by creditors..
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Part I.
Corporations have two primary sources of equity. The first is paid-in capital representing amounts that shareholders have invested by buying shares of stock from the company.
Part II.
The second source of equity is retained earnings. The retained earnings account reports the cumulative amount of net income the corporation has earned since its organization less the cumulative amount of dividends declared since organization. This is the portion of the net income that has been reinvested in the business rather than distributed to the owners in dividends.
Part III.
Accumulated other comprehensive income includes all changes in equity except those resulting from investments by owners and distributions to owners.
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Double taxation.
Government regulation.
The corporate form of organization has several advantages. The major advantage is the ease of raising large amounts of money because both large and small investors can participate in corporate ownership. In addition, corporate owners can transfer ownership rights very easily. Stockholders are generally free to buy and sell shares of common stock to others without permission from the corporation. Organized exchanges, such as the New York Stock Exchange, maintain markets in which shares in thousands of companies are bought and sold each business day. Stockholders’ losses are limited to the amount invested in the corporation. Corporate creditors cannot make claims on the personal assets of shareholders to satisfy corporate debt. Corporations are a separate legal entity that can enter into contracts and sue and be sued. The corporation continues in existence even when ownership changes.
Corporations also have some disadvantages. Corporations pay taxes on their earnings and then if they distribute a dividend to stockholders, the stockholders pay taxes on the dividends received. This is sometimes referred to as double taxation. Corporations are subject to many laws and regulations Large, publicly traded corporations are much more heavily regulated than smaller closely held corporations. They are subject to the provisions of the Securities and Exchange Commission Acts of 1933 and 1934, the Sarbanes-Oxley Act of 2002, and various exchange listing requirements.
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only a few individuals.
There are two basic types of corporations:
Not-for-profit corporations include hospitals, charities and government
agencies such as Federal Deposit Insurance Corporation.
For-profit corporations that may be either:
Publicly-held corporations whose shares are widely owned by the
general public, or .
Privately-held corporations whose shares are owned by only a few
individuals.
Our primary focus in this chapter is on corporations formed for the purpose of generating profits.
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Maximum number of owners.
All owners may be involved in management
without losing limited liability protection.
No limit on number of owners.
Limited liability partnership
Owners are liable for their own actions but not entirely liable for actions of other partners.
Double
taxation
avoided.
A corporation can elect to comply with specific tax rules and be designated an S corporation. Owners of S corporations have limited liability, but income and expenses are passed through to the owners, thereby avoiding double taxation. The number of owners of an S corporation is limited by law.
Owners of a limited liability company are not liable for the debts of the business except to the extent of their investment. All owners can be involved in the management of the company without losing their limited liability. Income and expenses are passed through to the owners so double taxation is avoided. Unlike an S corporation, there are no limits to the number of owners of a limited liability company.
A limited liability partnership is similar to a limited liability company except it doesn’t provide all of the liability protection. Owners are liable for their own actions but not entirely liable for the actions of other owners.
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Number and classes
of shares authorized.
Composition of initial
board of directors.
Nature and location
of business activities.
A corporate charter is granted by the state in which a business incorporates. The corporate charter describes the nature of the firm’s business, the number and classes of shares authorized to be issued, and the composition of the initial board of directors.
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Board of directors
corporate charter.
The requirements for forming a corporation are determined by the laws of the state where the business is incorporated. The Articles of Incorporation is the application for corporate status. Once granted a charter by the state, the corporation can issue shares of stock to investors. The stockholders of a corporation elect the members of the board of directors. In turn, the members of the board of directors hire the executive officers of the corporation. Finally, officers of the corporation empower others to hire needed employees. Employees, officers, and member of the board of directors may also be shareholders of the corporation
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percentage
ownership.
In addition to the right to buy and sells shares of stock, shareholders have the right to vote at the annual meeting of stockholders. Besides electing members of the board of directors, shareholders often vote on other issues of importance to the operations of the company. Shareholders receive dividends declared by the board of directors. In the event of liquidation, they share equally in any remaining assets after creditors are paid. Shareholders may also have the preemptive right to maintain their percentage ownership when new shares are issued.
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Authorized, Issued, and Outstanding Capital Stock
The maximum number of shares of capital stock that can be sold to the public is called the authorized number of shares.
Authorized
Shares
Authorized shares are the maximum number of shares of stock that can be sold to the public. The number of authorized shares is identified in the corporation’s charter that is issued by the state of incorporation.
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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 have never been sold.
Authorized
Shares
Seldom are all of the authorized shares sold to investors, so authorized shares are either issued or unissued. Issued shares are shares of stock that have been sold to investors at some point. Unissued shares are shares of stock that have never been sold to investors.
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Unissued
Shares
Treasury
Shares
Outstanding
Shares
Treasury shares are issued shares that have been reacquired by the corporation.
Issued
Shares
Outstanding shares are issued shares that are owned by shareholders.
Authorized
Shares
Issued shares can be classified as either outstanding shares or treasury shares. Outstanding shares are shares that are currently owned by shareholders. Treasury shares are shares that were once owned by shareholders but the corporation has repurchased the shares in the open market. After repurchase, the corporation is the owner of those shares.
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Unissued
Shares
Retired
Shares
Outstanding
Shares
Retired shares assume the same status as authorized but unissued shares.
Outstanding shares are issued shares that are owned by stockholders.
Authorized
Shares
When a corporation retires its reacquired shares (treasury shares), those shares assume the same status as authorized but unissued shares, just as if they had never been issued.
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Designated dollar amount per share stated in the corporate charter.
Par value has no relationship to market value.
No-par stock
Dollar amount per share not designated in corporate charter.
Corporations can assign a stated value per share (treated as if par value).
Common stock normally has a par value which is usually a very small amount, typically less than one dollar per share. In states that require a par value per share, the par value is also the legal capital that must remain invested in the business. Par value is an arbitrary amount assigned to each share of stock in the corporate charter, and it is not related in any manner to market value, which is the selling price of a share of stock.
In addition to par value stock, some states permit no-par value common stock. Some states permit no-par, stated value common stock. In those states, the stated value is treated just like the par value.
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Legal capital is . . .
The portion of shareholders’ equity that must be contributed to the firm when stock is issued.
The amount of capital, required by
state law, that must remain invested
in the business.
or full amount paid for no-par stock.
In states that require a par value or stated value per share, the par value or stated capital is also the legal capital. Legal capital is outdated concept that refers to:
The portion of shareholders’ equity that must be contributed to the firm when
stock is issued.
The amount of capital, required by state law, that must remain invested in the
business.
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Common
Preferred
There are two basic types of capital stock: common stock and preferred stock.
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Ranks after preferred stock for dividend and liquidation distribution.
Dividends determined by the board of directors.
Common stock is the basic voting stock of the corporation. It represents the residual claim on assets in liquidation. Dividends paid must first satisfy preferred stock agreements before any distribution can be made to common stockholders.
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redeemable.
Preferred stock is a separate class of stock that typically has priority over common stock in dividend distributions and distribution of assets in a liquidation. It normally does not have voting rights and is often callable by the corporation at a stated value. Some preferred stock issues have an additional preference to be converted into common stock at the stockholder’s choice.
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Preferred Stock Dividends
Are usually stated as a percentage of the par or stated value.
May be cumulative or noncumulative.
May be partially participating, fully participating, or nonparticipating.
Preferred stock usually has a stated dividend that is expressed as a percentage of its par value. Cumulative preferred stock has the right to be paid both the current and all prior periods’ unpaid dividends before any dividends are paid to common stockholders.
Noncumulative preferred stock has no rights to prior periods’ dividends if they were not declared in those prior periods. Most preferred stock is cumulative.
Preferred shares may also participate in dividends beyond the stated amount. Partially participating preferred shares have a limit on the amount of additional dividends. Fully participating preferred shares receive a pro rata share of all dividends declared based on the relative par value amounts of common and preferred shares outstanding. Most preferred stock is nonparticipating.
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Cumulative
Unpaid dividends must be paid in full before any distributions to common stock.
Dividends in arrears are not liabilities, but the per share and aggregate amounts must be disclosed.
When the preferred stock is cumulative and the directors do not declare a dividend to preferred stockholders, the unpaid dividend is called a dividend in arrears. All dividends in arrears on cumulative preferred stock must be paid in full before any dividends can be paid to common stockholders. Dividends in arrears are not liabilities because they have not been declared. However, the per share and aggregate amounts of dividends in arrears must be disclosed.
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Describe comprehensive income and its components.
Our second learning objective in Chapter 18 is to describe comprehensive income and its components.
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of gains and losses that traditionally have
been excluded from net income.
Net holding gains (losses) on investments.
Deferred gains (losses) from derivatives.
Net unrecognized loss on pensions.
Gains (losses) from foreign currency translations.
Comprehensive income is the total change in equity excluding only transactions with owners. Typical transactions with owners are dividends and the sale or repurchase of shares.
Comprehensive income starts with net income and adds or subtracts certain unrealized gains and losses that are not reported on the income statement. Comprehensive income includes four types of gains and losses that traditionally have been excluded from net income:
Net holding gains (losses) on investments.
Net unrecognized loss on pensions.
Gains (losses) from foreign currency translations.
Deferred gains (losses) from derivatives.
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($ in millions)
Net income $xxx
Other comprehensive income:
Net unrealized holding gains (losses) on investments (net of tax)† $ x
Net unrecognized loss on pensions (net of tax)‡ (x)
Deferred gains (losses) from derivatives (net of tax)§ x
Gains (losses) from foreign currency translation (net of tax)* x xx
Comprehensive income $xxx
‡ Reporting a pension liability sometimes requires recording this (described in Chapter 17). It often is called pension liability adjustment.
§ When a derivative designated as a cash flow hedge is adjusted to fair value, the gain or loss is deferred as a component of comprehensive income and included in earnings later, at the same time as earnings are affected by the hedged transaction (described in the Derivatives Appendix to the text).
* Gains or losses from changes in foreign currency exchange rates. The amount could be an addition to or reduction in shareholders’ equity. (This item is discussed elsewhere in your accounting curriculum.)
In the upper half of your screen you see an illustration of how comprehensive income, created during the current period, is reported. We start with net income and add or subtract the four types of gains and losses that traditionally have been excluded from net income to arrive at comprehensive income.
The information on the lower half of your screen provides some detail about the four items included in comprehensive income.
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Comprehensive Income
Comprehensive income is reported periodically as it is created and also is reported as a cumulative amount.
There are 3 options for reporting comprehensive income created during the reporting period.
The accumulated amount of comprehensive income is reported as a separate item of shareholders’ equity in the balance sheet.
As a separate statement in
a disclosure note.
Part I.
Comprehensive income is reported periodically as it is created and also is reported as a cumulative amount.
Part II.
There are 3 options for reporting comprehensive income created during the reporting period.
As an additional section of the income statement.
As part of the statement of shareholders’ equity.
As a separate statement in a disclosure note.
Part III.
The accumulated amount of comprehensive income is reported with retained earnings.
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Learning Objectives
Record the issuance of shares when sold for cash, for noncash consideration, and by share purchase contract.
Our third Learning objective in Chapter 18 is to record the issuance of shares when sold for cash, for noncash consideration, and by share purchase contract.
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Issuing Stock for Cash
10,000 shares of $1 par value stock is issued for $100,000 cash.
When shares of par value stock are issued for cash, we debit cash for the proceeds, credit common stock for the par value of the shares issued, and credit paid-in-capital in excess of par for the difference between the cash proceeds and the par value.
JAB
10,000 shares of no-par stock is issued for $100,000 cash.
When shares of no-par stock are issued for cash, we debit cash and credit common stock for the proceeds.
JAB
Issuing Stock for Cash
10,000 shares of no-par stock, with a stated value of $1 is issued for $100,000 cash.
When shares of no-par stock with a stated value are issued for cash, we debit cash for the proceeds, credit common stock for the stated value of the shares issued, and credit paid-in-capital in excess of stated value for the difference between the cash proceeds and the stated value.
JAB
Stated Value, Common Stock
Issuing Stock for Noncash Assets
Apply the general valuation principle by using fair value of stock given up or fair value of asset received, whichever is more clearly evident.
If market values cannot be determined, use appraised values.
When shares of stock are issued in exchange for noncash assets, we apply the general valuation principle we have seen in previous chapters. The transaction is valued at the fair value of stock issued or the fair value of asset received, whichever is more clearly evident. If the stock is actively traded on an exchange, we have an objective value to use for the transaction.
If fair values cannot be determined, then we must use appraised values.
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for a Single Price
Allocate the lump-sum received based on the relative fair values of the two securities.
If only one fair value is known, allocate a portion of the lump-sum received based on that fair value and allocate the remainder to the other security.
If more than class of shares is issued for a single price, we must allocate the lump-sum received based on the relative fair values of the two securities.
If only one fair value is known, we allocate a portion of the lump-sum received based on that fair value and allocate the remainder to the other security.
Let’s look at an example.
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for a Single Price
Toys, Inc. issued 5,000 shares of common stock, $10 par value and 3,000 shares of preferred stock, $5 par value for $450,000. The market values of the common stock and preferred stock were $55 and $75, respectively.
Calculate the additional paid-in
capital for each class of stock.
Toys, Inc. issued 5,000 shares of common stock, $10 par value and 3,000 shares of preferred stock, $5 par value for $450,000. The market values of the common stock and preferred stock were $55 and $75, respectively.
Calculate the additional paid-in capital for each class of stock.
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for a Single Price
Record the journal entry for issuing the stock.
First we calculate the total market values of the shares issued by multiplying the market value per share times the number of shares issued. For common stock, 5,000 shares times $55 per share equals $275,000, and for preferred stock, 3,000 shares times $75 per share equals $225,000, and the sum of these two amounts gives us a total market value of $500,000.
Next we divide the market value of each class of stock by the total market value of $500,000 to get the allocation percentages. For common stock, $275,000 divided by $500,000 equals 55 percent, and for preferred stock $225,000 divided by $500,000 equals 45 percent.
We multiply the allocation percentages times the $450,000 received to allocate the proceeds to each class of stock. For common stock, 55 percent of $450,000 is $247,500, and for preferred stock, 45 percent of $450,000 is $202,500.
Finally we subtract the total par value of each class of stock from the allocated amounts. For common 5,000 shares times $10 par value per share equals $50,000, and for preferred, 3,000 shares times $5 par value per share equals $15,000. The additional paid-in capital for common is $247,500 minus $50,000, or $197,500. The additional paid-in capital for preferred is $202,500 minus $15,000, or $187,500.
Now let’s record this transaction with a journal entry.
Sheet: Sheet1
Sheet: Sheet2
Sheet: Sheet3
Sheet: Sheet4
Sheet: Sheet5
Sheet: Sheet6
Sheet: Sheet7
Sheet: Sheet8
Sheet: Sheet9
Sheet: Sheet10
Sheet: Sheet11
Sheet: Sheet12
Sheet: Sheet13
Sheet: Sheet14
Sheet: Sheet15
Sheet: Sheet16
for a Single Price
We debit cash for the proceeds of $450,000. We credit common stock for its $50,000 par value and we credit preferred stock for its $15,000 par value. Then we credit additional paid-in capital for the two classes of stock, $197,500 for common and $187,500 for preferred.
JAB
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from selling shares, resulting in a lower
amount of additional paid-in capital.
Registration fees
Underwriter commissions
Promotional costs
When a company sells its shares to the public, it incurs certain costs called share issue costs. The costs include:
Registration fees
Underwriter commissions
Promotional costs
Share issue costs reduce net proceeds from selling shares, resulting in a lower
amount of additional paid-in capital.
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Dow Industrial sold 100,000 shares of its
$1 par value stock for $10 using a share
purchase contract. Forty percent of the sale
price was collected at sale and sixty
percent will be received in six months.
Prepare the journal entry for this transaction.
A share purchase contract is an agreement between a corporation and a subscriber whereby shares are sold in exchange for a promissory note. Normally corporations issue shares through investment bankers and brokerage firms, who then sell the shares to the public, but occasionally, share purchase contracts might be used. Consider the following example:
Dow Industrial sold 100,000 shares of its $1 par value stock for $10 using a share purchase contract. Forty percent of the sale price was collected at sale and sixty percent will be received in six months.
Prepare the journal entry for this transaction.
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It is reported as reduction in paid-in capital.
The total sale price of the shares is $1,000,000, calculated by multiplying 100,000 shares times the $10 per share sale price. We debit cash for $400,000 which is forty percent of the sale price that was collected at sale. We record the remaining sixty percent that will be collected in six months with a debit to receivable from share purchase contract for $600,000. We credit common stock for the $100,000 of par value and additional paid-in capital for the remainder of the issue price.
The $600,000 receivable from share purchase contract is not an asset. It is reported as reduction in paid-in capital.
JAB
600,000
reacquiring
shares.
Now that we have discussed issuing shares, let’s turn our attention to reacquiring shares.
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Support the market price.
Increase earnings per share.
Thwart takeover attempts.
A corporation might reacquire shares of its stock for a number of reasons including:
Supporting the market price.
Increasing earnings per share.
To thwart takeover attempts.
holding them as
treasury shares.
Regardless of the reasons for repurchasing shares of stock, companies can account for the repurchase in either of the follow ways:
The shares can be formally retired, or
They can be accounted for as treasury shares.
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Learning Objectives
Describe what occurs when shares are retired and how retirement is recorded.
Our fourth learning objective in Chapter 18 is to describe what occurs when shares are retired and how retirement is recorded.
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Accounting for Retired Shares
When shares are formally retired, we reduce the same capital accounts that were increased when the shares were issued – common or preferred stock, and additional paid-in capital.
When shares are formally retired, we reduce the same capital accounts that were increased when the shares were issued – common or preferred stock, and additional paid-in capital.
Consider the following example.
Accounting for Retired Shares
5,000 shares of $2 par value stock that were issued for $20 per share are reacquired for $17 per share.
Price paid is less than issue price.
First, let’s examine the case where the price paid to reacquire the shares is less than the original issue price.
The company pays $17 per share to reacquire 5,000 shares of $2 par value stock, that were originally issued for $20 per share.
We record this transaction by reducing common stock with a $10,000 debit for its par value, and by reducing paid-in capital in excess of par with a debit of $90,000. We credit cash for the amount paid, 5,000 shares times $17 per share equals $85,000. Finally, we credit paid in capital-share repurchase for $15,000, the difference between the $100,000 of proceeds from the original and the $85,000 paid to reacquire the shares.
JAB
90,000
Accounting for Retired Shares
5,000 shares of $2 par value stock that were issued for $20 per share are reacquired for $25 per share.
Price paid is more than issue price.
Reduce Retained Earnings if the
Paid-in Capital – Share Repurchase
account balance is insufficient.
Part I.
Now let’s examine the case where the price paid to reacquire the shares is more than the original issue price.
The company pays $25 per share to reacquire 5,000 shares of $2 par value stock, that were originally issued for $20 per share.
We record this transaction by reducing common stock with a $10,000 debit for its par value, and by reducing paid-in capital in excess of par with a debit of $90,000, the same entries as in the first case. We credit cash for the amount paid, 5,000 shares times $25 per share equals $125,000. Finally, we debit paid in capital-share repurchase for $25,000, the difference between the $100,000 of proceeds from the original and the $125,000 paid to reacquire the shares. The $25,000 debit to paid in capital-share repurchase assumes that a credit balance of at least $25,000 already exists in this account.
Part II.
If the credit balance is less than $25,000, we would debit retained earnings for the amount needed.
JAB
90,000
Distinguish between accounting for retired shares and for treasury shares.
Our fifth learning objective in Chapter 18 is to distinguish between accounting for retired shares and for treasury shares.
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shareholders’ equity.
Treasury stock has no voting or dividend rights. Dividends are not paid on treasury stock, and a corporation holding its own stock cannot vote the shares at the annual meeting. In the event of liquidation, the corporation receives no portion of the liquidated assets for the shares that it holds in the treasury.
Treasury stock is not an asset. The purchase of treasury stock reduces assets by the amount paid for the purchase. It is reported in the shareholders’ equity portion of the balance sheet as a reduction from total equity.
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Resale of Treasury Stock
Difference between cost and
issuance price is (generally)
recorded in paid-in capital –
share repurchase.
Using the cost method, we record (debit) treasury stock for the cost to purchase it. The total cost of all shares of treasury stock held by the company is the amount reported as a reduction in stockholders’ equity.
If the treasury stock is reissued, any difference between cost and issuance price is (generally) recorded in paid-in capital – share repurchase.
Let’s look at an example.
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Accounting for Treasury Stock
On 5/1/05, Photos-in-a-Second reacquired 3,000 shares of its common stock at $55 per share. On 12/3/06, Photos-in-a-Second reissued 1,000 shares of the stock at $75 per share. Which of the following would be included in the 12/3 entry?
a. Credit Cash for $165,000.
b. Debit Treasury Stock for $75,000.
c. Credit Treasury Stock for $55,000.
d. Credit Cash for $75,000.
On May 1, 2005 Photos-in-a-Second reacquired 3,000 shares of its common stock at a cost of $55 per share. On December 3, 2006, Photos-in-a-Second reissued 1,000 shares of the stock at price of $75 per share.
Would the reissue entry on December 3, 2006 include credit to cash for $165,000; a debit to treasury stock for $75,000; a credit to treasury stock for $55,000; or a credit to cash for $75,000?
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Accounting for Treasury Stock
On 5/1/05, Photos-in-a-Second reacquired 3,000 shares of its common stock at $55 per share. On 12/3/06, Photos-in-a-Second reissued 1,000 shares of the stock at $75 per share. Which of the following would be included in the 12/3 entry?
a. Credit Cash for $165,000.
b. Debit Treasury Stock for $75,000.
c. Credit Treasury Stock for $55,000.
d. Credit Cash for $75,000.
Solution
The correct answer is choice c. Let’s look at the entries for these two transactions to help us arrive at the correct answer to the question.
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Accounting for Treasury Stock
The cost of the treasury stock purchase is $165,000, calculated by multiplying 3,000 shares times $55 per share. The entry on May 1, 2005 requires a debit to treasury stock and a credit to cash for $165,000 for the cost of the purchase.
The proceeds of the sale are $75,000 calculated by multiplying 1,000 shares times $75 per share. The entry on December 3, 2006 requires debit to cash for $75,000; a credit treasury stock is for $55,000, the cost of 1,000 shares at $55 per share; and a $20,000 credit to paid-in capital – share repurchase for the difference between the reissue price and the cost of the treasury stock.
JAB
Dec. 3, 2006
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Equity.
The cost of treasury stock is reported as an unallocated reduction of total shareholders’ equity. In our example, Photos-in-a-Second would report an ending balance in its treasury stock account of $110,000 as a reduction is its shareholders’ equity. The $110,000 treasury stock balance results from the original debit entry for $165,000 less the credit entry for the sale for $55,000.
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it from paid-in-capital.
Our sixth learning objective in Chapter 18 is to describe retained earnings and distinguish it from paid-in-capital.
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Represents the undistributed earnings of the company since its inception.
Represents the undistributed earnings of the company since its inception. The most frequent changes to retained earnings are increases due to income and decreases due to distributions to owners, primarily dividends.
Sheet1
Retained Earnings
The statement of retained earnings may also contain the correction of an accounting error that occurred in the financial statements of a prior period, called a prior period adjustment.
Any restrictions on retained earnings
must be disclosed in the notes to the financial statements.
The statement of retained earnings may also contain the correction of an accounting error that occurred in the financial statements of a prior period, called a prior period adjustment. Some loan agreements place restrictions on the amount of dividends that can be paid based on the balance in retained earnings. Restrictions on retained earnings are generally disclosed in the notes to the financial statements.
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Section of a Balance Sheet
Here is an example of a shareholders’ equity section of a balance sheet. Notice that it reports both common and preferred stock at par value, additional paid-in capital for both common and preferred stock, and retained earnings.
Sheet1
authorized; 20,000 shares issued and
outstanding
$ 200,000
authorized; 400 shares issued and
outstanding
40,000
300,000
10,000
Explain the basis of corporate dividends, including the similarities and differences between cash and property dividends.
Our seventh learning objective in Chapter 18 is to explain the basis of corporate dividends, including the similarities and differences between cash and property dividends.
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to cover the dividend.
In order to declare and pay a cash dividend to shareholders, a corporation must have
Sufficient retained earnings to absorb the dividend with out going negative.
Enough cash to pay the dividend.
Dividends are not legally required but rather are declared at the discretion of the board of directors. When dividends are declared, a liability is created.
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Record a liability.
There are four important dates to remember when discussing dividends.
Declaration date.
Ex-dividend date.
Record date.
Payment date
The declaration date is the date the directors declare the dividend. At this time a liability is created. To record the dividend declaration, we debit retained earnings and credit the liability dividends payable.
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Dividend Dates
Ex-dividend date
The first day the shares trade without the right to receive the declared dividend.
(No entry)
July
X
The ex-dividend date is an important date for purchasers and owners of stock. This is the date which serves as the ownership cut-off point for the receipt of the most recent declared dividend. If you buy stock after this date but before the payment date, you will not receive the dividend. A journal entry is not required on the ex-dividend date.
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Date of record
Stockholders holding shares on this date will receive the dividend. (No entry)
July
X
X
July
The date of record is important to investors because the stock must be owned on this date to receive the dividend. Although a journal entry is not required on the record date, the company prepares a list of registered owners as of this date. The persons on that list will receive the dividend.
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dividend to stockholders.
On the payment date, the company debits dividends payable to remove the liability and credits cash for the amount of dividends paid.
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Record at fair value of non-cash asset.
Recognize gain or loss for difference between book value and fair value.
Property dividends are distributions of non-cash assets. The dividend is recorded at the fair value of the non-cash assets distributed.. A gain or loss for difference between book value and fair value of the assets distributed is recognized.
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Explain stock dividends and stock splits
and how they are accounted for.
Our eighth learning objective in Chapter 18 is to explain stock dividends and stock splits and how they are accounted for.
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All shareholders receive the same percentage increase in shares.
No change in total shareholders’ equity.
A stock dividend is a distribution of additional shares of stock to stockholders. Stock dividends do not change the assets or liabilities of the business. All stockholders retain the same percentage ownership. The stockholders have more shares of stock representing the same ownership as they had before the stock dividend. There is no change in total stockholders’ equity.
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Remind stockholders of the accounting wealth in the company, while
preserving cash..
Reduce the market price per share of stock to make the shares more
affordable for investors to purchase.
Signal that the management expects strong financial performance in the
future.
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of stock.
>
A stock dividend can be classified as small or large. A small stock dividend is a distribution of stock that is less than twenty-five percent of the outstanding shares. Small stock dividends are recorded at the market value of the stock.
A large stock dividend is a distribution of stock that is greater than or equal to twenty-five percent of the outstanding shares. Large stock dividends are recorded at the par value of the stock.
Let’s look at the entry to record a small stock dividend.
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Stock Dividends
CarCo declares and distributes a 20% stock dividend on 5 million common shares. Par value is $1 and market value is $20. Prepare the required journal entry.
CarCo declares and distributes a 20% stock dividend on 5 million common shares. Par value is $1 and market value is $20. Prepare the required journal entry.
Sheet: Sheet1
Sheet: Sheet2
Sheet: Sheet3
Sheet: Sheet4
Sheet: Sheet5
Sheet: Sheet6
Sheet: Sheet7
Sheet: Sheet8
Sheet: Sheet9
Sheet: Sheet10
Sheet: Sheet11
Sheet: Sheet12
Sheet: Sheet13
Sheet: Sheet14
Sheet: Sheet15
Sheet: Sheet16
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Stock Dividends
CarCo declares and distributes a 20% stock dividend on 5 million common shares. Par value is $1 and market value is $20. Prepare the required journal entry.
A small stock dividend requires a reclassification of retained earnings to paid-in capital equal to the fair value of the additional shares distributed.
The number of shares distributed is 20 percent of 5,000,000 shares outstanding or 1,000,000 shares. We multiply 1,000,000 shares times $20 per share to get the total market value of $20,000,000. Total par value is 1,000,000 times the $1 par value per share.
The journal entry requires a debit to retained earnings for $20,000,000, a credit to common stock for $1,000,000 and a credit to paid-in capital in excess of par for $19,000,000, the difference between the $20,000,000 market value and the $1,000,000 par value of the shares distributed.
Sheet: Sheet1
Sheet: Sheet2
Sheet: Sheet3
Sheet: Sheet4
Sheet: Sheet5
Sheet: Sheet6
Sheet: Sheet7
Sheet: Sheet8
Sheet: Sheet9
Sheet: Sheet10
Sheet: Sheet11
Sheet: Sheet12
Sheet: Sheet13
Sheet: Sheet14
Sheet: Sheet15
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No change in total stockholders’ equity.
Does not require a journal entry.
Ice Cream Parlor
Banana Splits On Sale Now
A stock split is the distribution of additional shares of stock to stockholders according to their percentage ownership. When a stock split occurs, the corporation calls in the outstanding shares and issues new shares of stock. In the process of a stock split, the par value of the stock changes, but retained earnings is unchanged. Each shareholder has the same percentage ownership of the company after the split as before the split. A journal entry is not required to record a stock split.
Let’s look at an example.
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before a 2–for–1 stock split.
Before the two-for-one split, the corporation had 5,000 shares of its $1 per share par value common ctock outstanding.
Let’s see what happens as a result of the two-for-one split.
Sheet1
before a 2–for–1 stock split.
After the split, the number of shares doubled to 10,000 and the par value was cut in half to $0.50 per share. There is no change in total par value of the shares outstanding. Notice that an accounting entry is not required, and that retained earnings is not reduced.
In many respects a one hundred percent stock dividend and a two-for-one stock split result in similar impacts to the price per share in the stock market. The stock split usually requires more administrative tasks to call in and reissue stock certificates.
Sheet1
Stock Splits Effected in the
Form of Large Stock Dividends
Matrix, Inc. declares and distributes a 2-for-1 stock split effected in the form of a 100% stock dividend. The company has 1,000,000, $1 par value common stock outstanding. The stock is trading in the open market for $14 per share. The per share par value of the shares is not to be changed.
Most investors refer to large stock dividends as stock splits. For example a 100 percent stock dividend may be called a two-for-one stock split. Even though it is referred to as a stock split, it is accounted for as a large stock dividend, with par value remaining unchanged.
Recall that large stock dividends are accounted for at par value. There are two approaches that a company might take:
Reduce paid-in capital in excess of par to offset the credit to common
stock for the par value of shares distributed.
Reduce (capitalize) retained earnings to offset the credit to common
stock for the par value of shares distributed.
Let’s look at the example on your screen for the first approach.
Matrix, Inc. declares and distributes a 2-for-1 stock split effected in the form of a 100% stock dividend. The company has 1,000,000, $1 par value common stock outstanding. The stock is trading in the open market for $14 per share. The per share par value of the shares is not to be changed.
We debit paid-in capital in excess of par and credit common stock for the $1,000,000 par value of the shares distributed.
Sheet1
1,000,000
Stock Splits Effected in the
Form of Large Stock Dividends
Matrix, Inc. declares and distributes a 2-for-1 stock split effected in the form of a 100% stock dividend. The company has 1,000,000, $1 par value common stock outstanding. The stock is trading in the open market for $14 per share. The per share par value of the shares is not to be changed and the company will capitalize retained earnings.
The second approach reduces retained earnings. The information is the same except for the last statement that says the company will capitalize retained earnings.
In this case, we debit retained earnings and credit common stock for the $1,000,000 par value of the shares distributed.
Sheet1
Purpose
To allow a company undergoing financial difficulty, but with favorable future prospects, to get a fresh start by writing down inflated assets and eliminating an accumulated balance in retained earnings.
A quasi reorganization allows a company undergoing financial difficulty, but with favorable future prospects, to get a fresh start by writing down inflated assets and eliminating an accumulated balance in retained earnings.
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Procedures
The firm’s assets and liabilities are revalued to reflect market values, with corresponding debits and credits to retained earnings.
The debit balance in retained earnings is eliminated first against additional paid in capital, and then, if necessary, against common stock.
Retained earnings is dated to indicate when the new accumulation of earnings began.
The following steps are followed in a reorganization:
The firm’s assets and liabilities are revalued to reflect market values, with
corresponding debits and credits to retained earnings.
The debit balance in retained earnings (deficit) is eliminated first against
additional paid in capital, and then, if necessary, against common stock.
Retained earnings is dated to indicate when the new accumulation of
earnings began.
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quasi reorganization, subject
to shareholder approval.
restatement, in millions, follows :
Emerson-Walsch Corporation has incurred losses for several years. The board
of directors voted to implement a quasi reorganization, subject to shareholder approval. Let’s examine the balance sheet prior to restatement.
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necessary for the quasi reorganization.
Fair value of the inventory is $300,000,000 and fair value
of the property, plant, and equipment is $225,000,000.
Notice the deficit in retained earnings. The quasi reorganization will eliminate this deficit, but first, we must restate the assets to reflect their fair values. Fair value of the inventory is $300,000,000 and fair value of the property, plant, and equipment is $225,000,000. Restating the assets to fair values that are lower than the balance sheet carrying value will increase the deficit in retained earnings.
Sheet1
(millions)
Cash
$ 75
Receivables
200
Inventory
375
400
800
To revalue assets.
The inventory fair value of $300,000,000 is $75,000,000 less than the amount shown on the balance sheet for inventory. The property, plant, and equipment fair value of $225,000,000 is $175,000,000 less than the amount shown on the balance sheet for property, plant, and equipment. We credit inventory and property, plant, and equipment to reduce them to fair value. We debit retained earnings to absorb the reductions in inventory and property, plant, and equipment. The $250,000,000 debit to retained earnings increases the retained earnings deficit from $300,000,000 to $550,000,000.
Sheet1
immediately after restatement.
$300 + $250
We credit retained earnings to eliminate the deficit (debit balance) of $550,000,000. The $150,000,000 balance in additional paid-in-capital is insufficient to absorb the entire deficit in retained earnings, so the remaining debit is to common stock for $400,000,000.
Sheet1
Quasi Reorganizations
After the quasi reorganization, assets are stated at fair value and the deficit in retained earnings has been eliminated.
Sheet1
Cash
$ 75
Receivables
200
Inventory
300
225
400
Net income25,000
Cash dividends(10,000)
Common Stock1,000,000
Total assets1,050$
Additional paid-in capital150
Retained earnings (deficit)(300)
Total assets800$
Additional paid-in capital0
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Common stock100,000
authorized; 20,000 shares issued and
outstanding200,000$
authorized; 400 shares issued and
outstanding40,000
Total paid-in capital550,000
Stated Value, Common Stock90,000
Paid-in Capital - Share Repurchase15,000
Paid-in Capital - Share Repurchase25,000
Dec. 3, 2006
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Total Par Value5,000$ 5,000$
Total assets1,050$
Additional paid-in capital150
Retained earnings (deficit)(300)
Total assets800$
Additional paid-in capital0
Shareholders' Equity
Captial Stock:
authorized; 20,000 shares issued and
outstanding200,000$
authorized; 400 shares issued and
outstanding40,000
Total paid-in capital550,000