© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Financial & Managerial Accounting

The Basis for Business DecisionsFOURTEENTH EDITION

Williams Haka Bettner Carcello

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

STOCKHOLDERS’ EQUITY:Paid-In Capital

Chapter

11

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Existence is separate from

owners.

An entity created by law.

Has rights and privileges.

Privately, or Closely, Held

Publicly Held

Ownership can be

Corporations

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Learning Objective

LO1

To discuss the advantages and disadvantages of

organizing a business as a corporation.

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Limited personal liability for

stockholders

Transferability of ownership

Professional management

Continuity of existence

Advantages of Incorporation

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Heavy taxation

Greater regulation

Cost of formation

Separation of ownership and management

Disadvantages of Incorporation

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Learning Objective

LO2

To distinguish between publicly owned and

closely held corporations.

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Publicly Owned Corporations Face Different Rules

By LAW, publicly owned corporations must:By LAW, publicly owned corporations must: Prepare financial statements in accordance Prepare financial statements in accordance

with GAAP.with GAAP. Have their financial statement audited by an Have their financial statement audited by an

independent CPA.independent CPA. Comply with federal securities laws.Comply with federal securities laws. Submit financial information for SEC review.Submit financial information for SEC review.

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

The costs associated with incorporation are usually

expensed immediately, but amortized over 5 years for

tax purposes.

Formation of a Corporation

• Each corporation is formed according to the laws of the state where it is located.

• The application for corporate status is called the Articles of Incorporation.

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Learning Objective

LO3

To explain the rights of stockholders and the

roles of corporate directors and officers.

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Stockholders

Rights

Voting (in person or by proxy).

Proportionate distribution of

dividends.Proportionate distribution of

assets in a liquidation.

Rights of Stockholders

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

C orpo ra te O rgan iza tion C hart

Secretary Treasurer C ontro ller O ther V icePresidents

President

B oard of D irectors

StockholdersUltimate control

Stockholders usually meet once a year.

Rights of Stockholders

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

C orpo ra te O rgan iza tion C hart

Secretary Treasurer C ontro ller O ther V icePresidents

President

B oard of D irectors

StockholdersUltimate control

Stockholders usually meet once a year.

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

registrar.

Rights of Stockholders

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Each unit of ownership is

called a share of stock.

Stock certificates serve as proof

that a stockholder has

purchased shares.

Rights of Stockholders

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

When the stock is sold, the stockholder

signs a transfer endorsement on the back of the

stock certificate.

Rights of Stockholders

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

C orpo ra te O rgan iza tion C hart

Secretary Treasurer C ontro ller O ther V icePresidents

President

B oard of D irectors

StockholdersOverall

responsibility for managing the company.

Selected by a vote of the

stockholders

Functions of the Board of Directors

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

C orpo ra te O rgan iza tion C hart

Secretary Treasurer C ontro ller O ther V icePresidents

President

B oard of D irectors

StockholdersChief

Accountant

Contractual and legal representation

Custodian of funds

Functions of the Corporate Officers

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Learning Objective

LO4

To account for paid-in capital and prepare the

equity section of a corporate balance

sheet.

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Paid-in Capital

Contributions byinvestors in exchange

for capital stock.

Retained Earnings

Retention of profitsearned by thecorporation.

Stockholders ' equity isincreased in tw o w ays.

Stockholders’ Equity of a Corporation

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

The maximum number of

shares of capital stock that can be

sold to the public.

AuthorizedShares

Authorization and Issuanceof Capital Stock

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

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.

AuthorizedShares

Authorization and Issuanceof Capital Stock

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

UnissuedUnissuedSharesShares

TreasuryShares

OutstandingShares

Treasury shares are issued shares that

have been reacquired by the corporation.

IssuedShares

Outstanding shares are issued shares that are

owned by stockholders.

AuthorizedShares

Authorization and Issuanceof Capital Stock

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

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.

Stockholders’ Equity

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Common stock can be issued in three forms:

No-Par Common

Stock

Par Value Common

Stock

Stated Value Common

Stock

All proceeds credited to

Common Stock

Treated like par value

common stock

Stockholders’ Equity

Let’s examine this form of

stock.

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Matrix, Inc. issues 10,000 shares of its $2 par value stock for $25 per share on

September 1, 2007.

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.

Issuance of Par Value Stock

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Issuance of Par Value Stock

Matrix, Inc. issues 10,000 shares of its $2 par value stock for $25 per share on

September 1, 2007.

10,000 × $2 = $20,000

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Issuance of Par Value Stock

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Learning Objective

LO5

To contrast the features of common stock with

those of preferred stock.

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

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.

Normally has no voting

rights.

Usually callable by

the company.

Other Features Include:

Preferred Stock

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Vs. NoncumulativeCumulativeDividends 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.

Cumulative Preferred Stock

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

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

During 2007, the directors declare cash dividends of $5,000. In 2008, the directors declare cash

dividends of $42,000.

Stock Preferred as to Dividends

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Stock Preferred as to Dividends

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

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!

Some preferred stock is convertible

into shares of common stock.

Other Features of Preferred Stock

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Preferred Stock

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Learning Objective

LO6

To discuss the factors affecting the market

price of preferred stock and common stock.

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Accounting by the issuer.

Accounting by the investor.

Common stock is carried at original issue

price.

Investments in marketable securities are carried at market

value.

Market Value

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Factors affecting market price of preferred stock:Factors affecting market price of preferred stock:• Dividend rateDividend rate• RiskRisk• Level of interest ratesLevel of interest rates

The return based on the market value is called the

“dividend yield.”

Market Price of Preferred Stock

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

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.

Market Price of Common Stock

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Learning Objective

LO7

To explain the significance of par

value, book value, and market value of capital

stock.

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Book Value per Shareof Common Stock

Total Stockholders’ EquityNumber of Common Shares Outstanding

Preferred stock and preferreddividends in arrears are deductedfrom total stockholders’ equity.

Book Value Market Value=

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Learning Objective

LO8

To explain the purpose and effects of a stock

split.

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Ice Cream Parlor

Banana Splits On Sale Now

Stock Splits

Companies use stock splits to reduce market price.

Outstanding shares increase, but par value is decreased proportionately.

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

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

before a 2–for–1 stock split.

Increase

Decrease

No Change

Stock Split

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Learning Objective

LO9

To account for treasury stock transactions.

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

No voting No voting or or

dividend dividend rightsrights

Contra equity

account

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 Stock

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

On May 1, 2007, East, Inc. reacquires 3,000 shares of its common stock at $55 per share.

Prepare the journal entry for May 1.

Treasury Stock - Example

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

On December 3, 2007, East Corp. reissued 1,000 shares of the stock at $75 per share.

Prepare the journal entry for December 3.

Treasury Stock - Example

1,000 shares × $55 cost = $55,000

1,000 shares × $75 = $75,000

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Stockholders’ Equity - Presentation

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

End of Chapter 11