Description
11/17/15
Notes for final exam on ch. 10 – analyzing stockholders’ equity
If bonds with a face value of $100,000 are sold for $96,000, how must this $4,000 difference be accounted for?
- Depreciated
- Amortized over the life of the bond
- Recorded as a loss on issuance
- Ignored
Assets = liabilities + stockholders’ equity Resources = obligations + “equities” or “ownership” Can get rid of, just pay it people who own our
company
ONLY COMPANY HAS OBLIGATIONS represents
partners
Owners/partners do NOT (the individual
owners)
[This chapter only deals with corporate structure, only business structure that has stock]
∙ Corporation
o Organized in under the laws of a particular state
o Corporate charter/Articles of Incorporation
o Separate legal entity
o Rights and privileges as a person
o Classified by purpose and ownership
Ownership – Publicly held vs. privately held
∙ Public
o Anyone can buy stock for this company
Most common: NY stock exchange
All those stocks are publicly traded
corporations If you want to learn more check out Who benefits from alienated labor?
Don't forget about the age old question of Differentiate genotype and phenotype.
Governed by securities & exchange
commission
∙ Dictates what must be done for
these companies
∙ One is that they must have audited
financial statements (very
expensive)
o People who are unbiased
(CPAs) come in & research a
bunch of things, then they
write a letter that basically
says this company is good to
go & can make good
decisions
∙ Private
o Not traded on exchange
o Distinguishing Characteristics
Separate legal “person”
Limited Liability of stockholders
∙ People trade stock they’ve bought & no longer want
Transferable ownership rights
Ability to raise capital Don't forget about the age old question of What are the steps in conducting scientific research?
Continuous life
∙ If a partner leaves the partnership, its dead (like
divorce)
∙ Corporation never dies, even if stock is sold
Corporation management
∙ Boards of directors hire management to dictate
affairs & general operations
Government regulations
Additional taxes We also discuss several other topics like Give a function of carbohydrates.
∙ Stockholders’ equity
o Represents the owners’ claims against the assets of a
corporation
Assets = Liabilities + Stockholders’ Equity / \
paid in capital retained earnings
(externally generated) (internally generated)
(comes from outside the company (provides capital to
fund/benefit resources)
in exchange for ownership)
o For a Corporation, most common sources are:
Paid-in Capital
∙ Common stock
∙ Preferred stock
o Only if we have a separate account of stock
that is preferred
o Not “better”, just has some preference that we
have to deal with
∙ Additional Paid-in Capital
o Par value
Legal capital per share We also discuss several other topics like Jwho is ames vanderzee?
Set based on state of corporation
Goes into legal capital accounts
∙ Par x number of shares goes in
preferred stock
∙ Usually sold above par, deal with
excess, used additional paid-in
capital account for this excess If you want to learn more check out Who is sigmund freud’s nephew?
Retained Earnings or deficit
Accumulated other comprehensive income
Treasury Stock
∙ Contra-equity account
o Deduction (subtracted) from total
stockholders’ equity
∙ Measure of stock that we own bc we went back to the market & repurchased (buy back) previously
purchased stock
∙ Authorized, issued, & outstanding shares
o Authorized shares – the maximum number of shares allowed to be sold
Identified in the corporate charter
No entry (disclosed on the financial statement or in notes) o Issued shares – the number of shares actually sold to stockholders
Go to common stock/preferred stock accounts
∙ “Issued shares” is code word for selling stock, any
amount above par goes to additional paid-in-capital
while par value goes to common/preferred stock
accounts
Always bigger/equal to authorized shares
Formation of corporation
Ongoing
o Outstanding shares – the number of issued shares actually in the hands of stockholders
Considers shares bought back by the company “Treasury Stock”
Difference between Issued and Outstanding shares is the reacquired shares
∙ Determination of share quantities
∙ Common stock
o Stock Certificate – proof of ownership
o Legal Capital Account – par x # shares (preferred/common stock account)
Sale above par – additional paid-in-capital account
o Ownership rights
Voting
Pro rata participation in dividends
∙ “pro rata” means fair & equal
Pro rata participation in residual assets
Preemption – maintaining ownership percentage
∙ You have the right to be able to keep your status in
terms of percentage of ownership share
∙ Corporation can’t do something that causes one
owner to have a bigger share than another, would
have to be extended to all shareholders
o Financial gain from a profitable company (why buy shares) Stock appreciation (Capital Gain)
∙ Buy low now, sell high later
Dividends
∙ Looking for some kind of interest/dividend income,
stream of cash flow, that they need when they’re 90
years old with no job
∙ What old grandmas have
∙ Preferred stock
o Stock Certificate
o Separate class of stock- different account
o Less risky than Common Stock
o Par Value x # shares = Preferred Stock
o Sale above par – additional Paid in Capital account
o Preference as to Dividends and Liquidation over Common Stockholders.
o Preferred stock generally pays regular dividend – typically expressed in terms of % of par
o Cumulative dividends feature – dividends in arrears plus current dividends must be paid
If company says they’re going to pay dividend, they have to
o Dividends in arrears is NOT a liability since no obligation exists until dividends are declared
∙ Entries: stock issue
o Sale at Par Value:
Cash x, xxx
Common Stock x, xxx
o Sale above Par value:
Cash x, xxx
Common Stock x, xxx
Paid-in Capital x, xxx
∙ Ex) 10-25 recording the sale of stock
o Donahue corporation is authorized by its charter from the state of Illinois to issue 2,000 shares of 7% preferred stock with a par value of $30 per share, and 125,000 shares of common stock with a par value of $0.01 per share.
o On Jan 1, 2013, Donahue issues 1,300 shares of preferred stock for $35 a share and 84,000 shares of common stock for $12.50 per share. Record the stock sale.
o Issue preferred stock:
1/1/13 Cash 45,500 (1,300 x $35)
Preferred stock 39,000 (1,300 x $30) par
Additional paid-in-capital 1,600 (1,300 x $5) excess of par
o Issue common stock:
1/1/13 Cash 1,050,000 (84,000 x $12.50) Common stock 840 (84,000 at $0.01) par
Additional paid-in-capital 1,049,160 (84,000 x $12.49) excess
∙ Ex) The stockholders’ equity section of Lester company’s balance sheet shows the following:
o Stockholders’ equity
Common stock, 500,000 shares authorized,
450,000 shares issued $450,000
Additional paid-in-capital $4,050,000 Retained earnings $1,425,000 Treasury stock, at cost, 16,000 shares ($480,000)
o Total stockholders’ equity = $5,445,000 o Answer the following:
Number of shares authorized?
500,000
Number of shares issued?
450,000
Number of shares outstanding?
434,000
(450,000 – 16,000)
Par value per share of common stock? $1 How much has been received from issuance of stock?
$4,500,000
(450,000 + 4,050,000)
What is the avg. cost of a share of treasury stock?
$30
(480,000/16)
A company issues 200 shares of $2 par value common stock for $10 per share. What amount will be credited to the common stock account when recording this transaction?
- $400
- $2,000
- $1,600
- none of the above
After Thanksgiving Break
11/29/16
A company issues 400 shares of %5 par value preferred stock for $12 per share. What amount will be credited to the Preferred Stock account when recording this transaction?
- $4,800
- $2,000
- $2,800
- none of the above
A company issues 400 shares of %5 par value preferred stock for $12 per share. What amount will be credited to the Paid in Capital in Excess of Par Preferred Stock account when recording this transaction?
- $4,800
- $2,000
- $2,800
- none of the above
A company issues 400 shares of %5 par value preferred stock for $12 per share. What amount will be debited to the Cash account when recording this transaction?
- $4,800
- $2,000
- $2,800
- none of the above
Journal Entry:
Cash 4,800 (selling price)
Preferred Stock 2,000 (par value)
Addition PIC-PS 2,800 (excess)
∙ Stock Warrants
o Stock warrant – right to purchase a specified number of shares of its common stock at a stated price and within a stated time period
Basically a right that allows that person to buy a certain number of shares at a certain price during a certain time
Usually attached as “equity kicker” (attached to allow
ownership to increase percentage share of ownership in
company)
Detachable (can go with shares of stock or debt)
∙ Usually on bonds
∙ Option to be a lender and have an equity (ownership)
position in company
o Two situations:
Give an “equity kicker” to make the bonds or preferred stock more attractive. Typical duration of 5+ years.
Give existing stockholders who have a legal right to
purchase a specified share of a new stock issue, in order to maintain their relative level of ownership in the
corporation. Typical duration less than six months
∙ Stock Options
o Stock Options – right to buy stock at a set price
compensation for employees & executives
ex) stock options were how people made big money,
salaries were good, sales reps made a lot of money
∙ Regional VPs got stock options
∙ Didn’t make big money through salaries and
incentives, but through stock options
∙ Ability to buy stock in company lower than market,
everyone wanted it in this company that Cornett
worked for (Green Tree)
∙ Options are reserved for key employees (people you
want to attract & retain)
o Exercise Price (aka Strike Price) – price at which stock can be bought
Compensation expense depends on the strike price and market value on the date of the grant
o Why?
Allows cash-poor companies to compete for top talent in the employee market
Better aligns the incentives of the employee with owners ∙ Treasury Stock
o Treasury Stock – repurchase of company stock previously issued
o Why?
Reduced # of shares & increase EPS
Eliminate hostile shareholders by buying them out
∙
Signal stock is underpriced
Reissue to officers & employees as bonus
Distribute cash to shareholders
o Cost method is used:
Treasury Stock x, xxx
Cash x, xxx
Ex) Kellman Co. repurchased 110,000 shares of its own previously issued shares for $8 per share on September 4, 2014. Record the journal entry: 110,000 x $8 = $880,000 total cost
9/4/14: Treasury Stock 880,000
Cash 880,000
Kellman subsequently resells 60,000 of its treasury shares for $10 per share. Record the journal entry:
60,000 x $10 = $600,000 (cash)
60,000 x $8 = 480,000 (treasury stock)
Cash 600,000
Treasury Stock 480,000
Addition PIC 120,000
∙ Dividends (company does well, they want to share the fruits of the labor with the people who invested; given related to how much equity you own)
o Pro-rata distribution (fair and equitable) to stockholders, usually quarterly
Declaration date
∙ intention and dollar amount of dividend
∙ Becomes legally binding; obligation is recognized
∙ Legal requirement prior to payout of dividend
Record date
∙ Measurement of ownership
∙ Who gets the dividend?
Payment date
∙ Date dividend is actually paid to the stockholder of
record
o Dividend policy
Board of Directors
Stockholders & potential investors
Historical records & long-term stability
Liquidating dividends- dividends are declared when R/E is zero
o entries for cash dividends
Declaration date – binding legal obligation
Retained Earnings x, xxx
Dividends Payable x, xxx
Record date
∙ Marks the time when ownership of the outstanding
shares is determined for dividend purposes
∙ No accounting entry
Payment date – checks are sent to stockholders
Dividends Payable x, xxx
Cash x, xxx
Ex) Wilson Co. declares a cash dividend of $80,000 on Dec. 31, 2013. The dividend payment date is Feb. 12, 2014 and the date of record is Jan. 20, 2014.
Declaration Date Entry:
12/31/13: Retained earnings 80,000
dividends payable 80,000
Record date entry:
1/20/14: NO ENTRY
Payment Date Entry:
2/12/14: dividends payable 80,000
cash 80,000
∙ Preferred stock dividends
o Current dividend preference – preferred shareholders get their stated dividend before any dividends go to common stockholders
Preference only
No guarantees of a dividend
o A cumulative feature means the stated dividend can build up in the event that dividends are not paid in a given year
Dividends in arrears- Preferred stock dividends remaining unpaid for one or more years
Requires payment of all preferred dividends (both
dividends in arrears and current dividends) before any
dividends are paid to common stockholders
Ex) Seashell Co. has 25,000 shares outstanding of 8%, $10 par value, cumulative preferred stock. In 2011 and 2012, no dividends were declared or paid to stockholders. In 2013, Seashell had a very profitable year and decided to declare $200,000 in total dividends to be paid out. How much of the dividend would go to each class of stockholders?
25,000 shares @ $10 = $250,000 x 8% = $20,000 (annual preferred stock dividend – annual requirement for dividend)
2011: $20,000
2012: $20,000 2 years of dividends in arrears 2013: $20,000 for this year = $60,000 to preferred stockholders = $140,000 to common stockholders
= $200,000
Declaration date:
Retained Earnings 200,000
P/S dividends payable 60,000
C/S dividends payable 140,000
BONUS:
Adam Levine has invested $1,000,000 for a 40% stake in a privately held family corporation. The corporation does not do well and declares bankruptcy. What amount does Adam stand to lose?
- Up to his total investment of $1,000,000
- Nothing
- The $1,000,000 plus any personal assets claimed by the creditors - $400,000
A company with 4,000 shares of $1 par commons tock and 3,000 shares of 10%, $10 par preferred stock issues a $10,000 cash dividend. How is the dividend allocated to common and preferred stockholders if there was one year of dividends in arrears? ONE YEAR (cumulative)
- $6,000 – common; $4,000 – preferred
- $4,000 – common; $6,000 – preferred
- $7,000 – common; $3,000 – preferred
- $3,000 – common; $7,000 – preferred
12/1/16
Assets = Liabilities + Stockholders’ Equity
Cash Dividend
1. Declared N/E = increase dividend payable + decrease R/E (increase dividend)
2. Paid decrease Cash = decrease dividend payable + N/E
Stock Dividend
N/E = N/E + decrease R/E, increase PIC
Stock Split
N/E = N/E + N/E
Assets = Liabilities + Stockholders’ Equity / \
“Paid in Capital” “Retained Earnings”
+ Common Stock “ “
+ Preferred Stock Stock Dividend
+ Paid in Capital in Excess of Par “ “
– Treasury Stock “ “
A company with 4,000 shares for $1 par common stock and 3,000 shares of 10%, $10 par preferred stock issues a $10,000 cash dividend. How is the dividend allocated to common and preferred stockholders? - $6,000 – common; $4,000 – preferred
- $4,000 – common; $6,000 – preferred
- $7,000 – common; $3,000 – preferred
- $3,000 – common; $7,000 – preferred
A company with 4,000 shares for $1 par common stock and 3,000 shares of 10%, $10 par cumulative preferred stock issues a $10,000 cash dividend. How is the dividend allocated to common and preferred stockholders if there was one year of dividends in arrears?
- $6,000 – common; $4,000 – preferred
- $4,000 – common; $6,000 – preferred
- $7,000 – common; $3,000 – preferred
- $3,000 – common; $7,000 – preferred
∙ Stock Dividend
o Pro-rata distribution of stock to stockholders
o Decreases retained earnings
o Increases paid-in capital
o Does not decrease stockholders’ equity or total assets like a cash dividend
o Stockholders get more shares of stock, but have the same ownership interest
∙ Why declare a stock dividend??
o Meet dividend expectations without spending cash
o Increase marketability of stock
Price per share decreased
Available to more investors
o Permanent reinvestment of stockholders’ equity – not available for cash dividends
∙ Impact of Stock Dividends
o Changes composition of stockholders’ equity
Retained earnings is transferred to paid-in capital
Total S/E remains the same
o Recording stock dividends
Small (less than 25% of issued shares)
∙ Fair Market Value per share
Large (more than 25% of issued shares)
∙ Par or Stated Value per share
Ex) 10-69 stock dividends
∙ Crystal corporation has the following info with regard to its common stock:
o $10 par
o 500,000 shares authorized (available to sell/issue)
o 213,000 shares issued (what we did sell/issue)
o 183,700 shares outstanding (difference bw authorized & issued – treasury stock)
∙ On Aug. 22, 2013, Crystal declared & paid a 15% stock dividend when the market price per share was $30
o 15% of outstanding shares (small dividend bc less than 25%) x 183,700 = 27,555 shares (shares in dividend)
o use market price bc small dividend
27,555 shares x $30 = $826,650 (debit/decrease to
retained earnings)
∙ Prepare the journal entry required on Aug. 22, 2013
8/22/13 Retained Earnings 826,650
Common Stock 275,550 ($10 par)
Additional Paid in Capital CS 551,100 ($20)
∙ What if Crystal declared a 30% stock dividend instead (large dividend so use par value)?
o 183,700 x 30% = 55,110 shares
∙ Prepare the journal entry required on Aug. 22, 2013
8/22/13 Retained Earnings 551,100 (55,110 x $10 par value) Common Stock 551,100
∙ Stock Splits (lowering stock price which makes your stock more sellable – more people who can buy the stock, requires less of an investment)
o Issues additional shares to stockholders
o Increases marketability
Reduces the market value of the stock
Total number of shares increases
Par value of the shares decreases
o Number of shares increases
o No accounting entry
No effect on total paid-in capital, retained earnings or total stockholders’ equity
∙ Ex) stock split illustration
o Trump Enterprises has 100,000 authorized, issued, and outstanding shares at $5 par value stock.
o What is the impact of a 4-for-1 stock split?
If 100,000 before 4-for-1, then it becomes 400,000 after the split (100,000 x 4)
Par value is $5 / 4 = $1.25
Before split: 100,00 shares at $5 each = $500,000 After split: 400,000 shares at $1.25 each= $500,000
Value doesn’t change, just the components that make the value o What if the stock split was 2-for-1?
Before split: 100,000 shares at $5 = $500,000 ∙ $5 / 2 = $2.50
After split: 200,000 shares at $2.50 = $500,000
∙ If the market value of each share of $22, what would the anticipated value at each share of stock be if Trump had 4-for-1 split?
o Before split: 100,000 x $22 = $2,200,000 (pie (market value)) $22 / 4 = $5.50
o After split: $2,200,000 / 400,000 = $5.50 per share
∙ Retained Earnings
o Retained earnings – the accumulated earnings (or losses) over the entire life of the corporation that have not been paid out in dividends
Ending Retained Earnings = Beginning Retained Earnings + Net Income – Dividends
o Restrictions on R/E
State law
Upper limit on dividends
Lenders (Bonds/LTD)
Board of Directors
o Prior period adjustment – if an error resulted in a misstatement of net income, then correction may require a direct adjustment to retained earnings
∙ Accounting for accumulated other comprehensive income (NOT ON FINAL)
o Financial accounting theory suggests that income represents the changes in the assets and liabilities of the company as a result of transactions with nonowners
o However, over time the FASB has allowed the gains and losses from certain nonowner transactions to bypass the income statement and go directly to stockholders’ equity.
Includes estimation errors/change in estimate
Includes change in accounting principle
o Companies are required to include these gains and losses, along with net income in a measure called comprehensive income. o FASB allows one of 3 methods
Include a statement of changes in stockholders’ equity which includes a column for comprehensive income.
A ‘‘second’’ income statement, which begins with net
income, then shows items such as unrealized gains and
losses on available-for-sale investments and finally totals to comprehensive income.
A combined statement of comprehensive income, which includes both net income and comprehensive income on
the same statement.
o accumulated other comprehensive income is shown in the stockholders’ equity section of the balance sheet.
The final option is to present a combined statement of
comprehensive income, which includes both net income
and comprehensive income on the same statement.
o Regardless of which option is used to disclose comprehensive income for the period, accumulated other comprehensive income is shown in the stockholders’ equity section of the balance sheet.
∙ Evaluation of S/E
o Stockholder Profitability
Return on Common Equity
Net income – preferred stock dividends/Average Common Stockholders Equity
∙ How effectively equity is used to generate more
equity
Earnings Per Share
Net Income – preferred stock dividends/Average # Common Shares ownings per share
∙ Good for year to year comparison
o Stockholder Payout
Dividend Payout Ratio
∙ Common Dividends/Net Income
Dividend Yield Ratio
∙ Dividends Per Common Share/Market Price Per Share
C/S
∙