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Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin.

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Presentation on theme: "Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin."— Presentation transcript:

1 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

2 Chapter 11 Reporting and Interpreting Stockholders’ Equity PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Fred Phillips, Ph.D., CA

3 Learning Objective 1 Explain the role of stock in financing a corporation 11-3

4 Corporate Ownership The major advantage of the corporate form of business is the ease of raising capital as both large and small investors can participate in corporate ownership. Simple to become an owner Easy to transfer ownership Provides limited liability Because a corporation is a separate legal entity, it can  Own assets.  Incur liabilities.  Sue and be sued.  Enter into contracts. 11-4

5  Voting rights.  Dividends.  Residual claims. Stockholder Benefits Corporate Ownership  Preemptive rights. 11-5

6 Elected by shareholders Appointed by directors Corporate Ownership 11-6

7 Equity Versus Debt Financing Advantages of equity Equity does not have to be repaid. Dividends are optional. Advantages of debt Interest on debt is tax deductible. Debt does not change stockholder control. Advantages of equity and debt financing. 11-7

8 Learning Objective 2 Explain and analyze common stock transactions. 11-8

9 Two primary sources of Stockholders’ Equity Common Stock Transactions Contributed Capital Common Stock Additional Paid-in Capital Retained Earnings 11-9

10 Authorization, Issuance, and Repurchase of Stock The maximum number of shares of capital stock that can be issued to the public. Issued shares are authorized shares of stock that have been distributed to stockholders. Unissued shares of stock are shares that have never been distributed to stockholders. Unissued Shares Treasury Shares Outstanding Shares Issued Shares Treasury shares are issued shares that have been reacquired by the corporation. Outstanding shares are issued shares that are owned by stockholders. Authorized Shares 11-10

11 Authorization, Issuance, and Repurchase of Stock 11-11

12 Par value is typically a very nominal amount such a $0.01 per share. Stock Authorization 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.  11-12

13 Some states do not require a par value to be stated in the charter. No-par Stock Stock Authorization 11-13

14 Stock Issuance Initial public offering (IPO) The first time a corporation issues stock to the public. Seasoned new issue Subsequent issues of new stock to the public. National Beverage issues stock

15 Most issues of stock to the public are cash transactions. Stock Issuance National Beverage issued 100,000 shares of $0.01 par value common stock for $10 per share. 1 Analyze Record

16 Stock Exchanged between Investors Transactions between two investors do not affect the corporation’s accounting records. I’d like to sell 100 shares of National Beverage stock. I’d like to buy 100 shares of National Beverage stock

17 Repurchase of Stock A corporation repurchases its stock to:  Send a signal that the company believes its stock is undervalued.  Obtain shares to reissue for the purchase of other companies.  Obtain shares to reissue to employees as part of stock purchase or stock option plans. Treasury Stock 11-17

18 Repurchase of Stock National Beverage repurchases its own stock (Treasury stock) Stockholders Stock options allow employees to purchase stock from the corporation at a fraction of the stock’s market price. Employee Employee compensation package includes salary plus stock options

19 No voting or dividend rights Contra equity account When stock is reacquired, the corporation records the treasury stock at cost. Treasury stock is not an asset. Repurchase of Stock 11-19

20 National Beverage reacquired 50,000 shares of its common stock at $25 per share. Repurchase of Stock 1 Analyze Record

21 Reissuance of Treasury Stock National Beverage reissued 5,000 shares of the Treasury Stock at $26 per share. No profit or loss is recognized on treasury stock transactions. 1 Analyze Record

22 Learning Objective 3 Explain and analyze cash dividends, stock dividends, and stock split transactions

23 Dividends on Common Stock Declared by board of directors. Not legally required. Creates liability at declaration. Requires sufficient Retained Earnings and Cash

24 If I loan your company $1,000,000, I will want you to restrict your retained earnings to limit dividend payments. Restrictions on Retained Earnings Loan agreements can include restrictions on paying dividends below a certain amount of retained earnings

25 Dividends Dates 11-25

26 Dividends Dates National Beverage declares an $0.80 dividend on each share of its 46,000,000 shares of common stock outstanding. 1 Analyze Record

27 Dividends Dates National Beverage paid the previously declared $0.80 dividend on its shares of common stock outstanding. 1 Analyze Record

28 No change in total stockholders’ equity. No change in par values. All stockholders retain same percentage ownership. Stock Dividends Corporations issue stock dividends to:  Remind stockholders of the accumulating wealth in the company.  Reduce the market price per share of stock.  Signal that the company expects strong financial performance in the future. Distribution of additional shares of stock to stockholders

29 Record at current market value of stock. Record at par value of stock. SmallLarge The journal entry moves an amount from Retained Earnings to other equity accounts. Stock Dividends Stock dividend > 20 – 25% Stock dividend < 20 – 25% 11-29

30 National Beverage issued a 20 percent stock dividend on 38,000,000 outstanding shares of its $0.01 par value common stock and accounted for it as a large stock dividend. Stock Dividends 1 Analyze Record

31 Stock Splits An increase in the number of shares and a corresponding decrease in par value per share. Retained earnings is not affected. A stock split creates more pieces of the same pie. 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 11-31

32 Comparison of Distributions to Stockholders 11-32

33 Learning Objective 4 Describe the characteristics of preferred stock and analyze transactions affecting preferred stock

34 Preferred Stock Issuance National Beverage issued 10,000 shares of its $1 par value preferred stock for $5 per share. National Beverage issued 10,000 shares of its $1 par value preferred stock for $5 per share. 1 Analyze Record 2 Usually has no voting rights Usually has a fixed dividend ratePreferred Stock Priority over common stock 11-34

35 Preferred Stock Dividends Current Dividend Preference: The current preferred dividends must be paid before paying any dividends to common stock. Cumulative Dividend Preference: Any unpaid dividends from previous years (dividends in arrears) must be paid before common dividends are paid. If the preferred stock is noncumulative, any dividends not declared in previous years are lost permanently

36 In addition to its common stock, National Beverage has $1 par value cumulative preferred stock with a 7 percent dividend rate. Assume 100,000 of these shares are outstanding, one year of dividends are in arrears, and the board of directors just declared total dividends of $400,000. How much will each class of stock receive? Preferred Stock Dividends 11-36

37 Preferred Stock Dividends 11-37

38 Retained Earnings Total cumulative amount of reported net income less any net losses and dividends declared since the company started operating. Baker Company incurred a loss of $120,000 in 2009 that resulted in an Accumulated Deficit in Retained Earnings

39 Learning Objective 5 Analyze the earnings per share (EPS), return on equity (ROE), and price/earnings (P/E) ratios

40 Net Income Average Number of Common Shares Outstanding EPS = National Beverage’s income for 2008 was $22,500,000 and the average number of shares outstanding during the year was 45,900,000. Earnings per share is probably the single most widely watched financial ratio. Earnings Per Share (EPS) $22,500,000 45,900,000 Shares EPS = = $0.49 per share 11-40

41 Return on Equity (ROE) Net Income Average Stockholders’ Equity ROE = National Beverage’s income for 2008 was $22,500,000 and the average Stockholders’ Equity was $151,000,000. Return on equity is the amount earned for each dollar invested by stockholders. $22,500,000 $151,000,000 ROE = = 14.9 percent 11-41

42 Price/Earnings (P/E) Ratio Current Stock Price (per share) Earnings Per Share (annual) P/E = The P/E ratio is a measure of the value that investors place on a company’s common stock. National Beverage’s stock price was $7.74 when the company reported its 2008 EPS of $0.49. $ 7.74 $ 0.49 P/E = =

43 Comparison of EPS, ROE, and P/E Ratios 11-43

44 Supplement 11A Owners’ Equity for Other Forms of Business

45 Owner’s Equity for a Sole Proprietorship Only two owner’s equity accounts. A withdrawal account to record the owner’s withdrawals of assets. A capital account to record the owner’s investments and the periodic income or loss. Closed to the capital account at the end of each period. No separate retained earnings account

46 Accounting for Owner’s Equity for a Sole Proprietorship To record a $150,000 investment by H. Simpson, the owner. To record H. Simpson’s $1,000 monthly withdrawal

47 Accounting for Owner’s Equity for a Sole Proprietorship To close revenue and expense accounts to capital. To close the $1,000 monthly drawings to capital

48 Accounting for assets, liabilities, revenues and expenses follows the same accounting principles as any other form of business. Accounting for partners’ equity follows the same pattern as for a sole proprietorship. Separate capital and drawings accounts are maintained for each partner. Accounting for Partnership Equity 11-48

49 Accounting for Partnership Equity To record investments by partners Able and Baker who will divide net income as follows: Able, 60 percent and Baker 40 percent. To record the partners’ monthly withdrawal

50 Accounting for Partnership Equity To close revenue and expense accounts to partners’ capital. To close the monthly drawings to partners’ capital

51 Other Business Forms Limited Liability Partnership (LLP) Protects innocent partners from malpractice or negligence claims. Most states hold all partners personally liable for partnership debts. Limited Liability Company (LLC) Owners have same limited liability feature as owners of a corporation. A limited liability corporation typically has a limited life

52 Chapter 11 Solved Exercises M11-4, M11-8, E11-3, E11-6, E11-8, E11-11, E11-20

53 M11-4 Analyzing and Recording the Issuance of Common Stock To expand operations, Aragon Consulting issued 100,000 shares of previously unissued common stock with a par value of $1. The price for the stock was $75 per share. Analyze the accounting equation effects and record the journal entry for the stock issuance. Analyze 1 Record

54 M11-4 Analyzing and Recording the Issuance of Common Stock Would your answer be different if the par value were $2 per share? If, so, analyze the accounting equation effects and record the journal entry for the stock issuance with a par value of $2. Analyze 1 Record 2 The effects on total assets and total stockholders’ equity would not differ, but the amounts within the individual stockholders’ equity accounts would differ

55 M11-8 Determining the Amount of a Dividend Netpass Company has 300,000 shares of common stock authorized, 270,000 shares issued, and 100,000 shares of treasury stock. The company’s board of directors declares a dividend of 50 cents per share of common stock. What is the total amount of the dividend that will be paid? Dividends are paid on shares that are issued and outstanding. Dividends are not paid on treasury stock

56 E11-3 Preparing the Stockholders’ Equity Section of the Balance Sheet North Wind Aviation received its charter during January The charter authorized the following capital stock: During 2010, the following transactions occurred in the order given: a. Issued a total of 40,000 shares of the common stock to the company’s founders for $11 per share. b. Issued 5,000 shares of the preferred stock at $18 per share. c. Issued 3,000 shares of the common stock at $14 per share and 1,000 shares of the preferred stock at $28. d. Net income for the first year was $48,000. Required: Prepare the stockholders’ equity section of the balance sheet at December 31,

57 E11-3 Preparing the Stockholders’ Equity Section of the Balance Sheet 5,000 shares × ($18 – $10) + 1,000 shares × ($28 – $10) 40,000 shares × ($11 – $7) + 3,000 shares × ($14 – $7) 11-57

58 E11-6 Recording and Reporting Stockholders’ Equity Transactions AvA School of Learning obtained a charter at the start of 2010 that authorized 50,000 shares of no-par common stock and 20,000 shares of preferred stock, par value $10. During 2010, the following selected transactions occurred: a. Collected $40 cash per share from four individuals and issued 5,000 shares of common stock to each. b. Issued 6,000 shares of common stock to an outside investor at $40 cash per share. c. Issued 8,000 shares of preferred stock at $20 cash per share. Required: 1. Give the journal entries indicated for each of these transactions. 2. Prepare the stockholders’ equity section of the balance sheet at December 31, At the end of 2010, the accounts reflected net income of $36,000. No dividends were declared

59 E11-6 Recording and Reporting Stockholders’ Equity Transactions Required: 1. Give the journal entries indicated for each of these transactions. (a) Collected $40 cash per share from four individuals and issued 5,000 shares of common stock to each. (b) Issued 6,000 shares of common stock to an outside investor at $40 cash per share

60 E11-6 Recording and Reporting Stockholders’ Equity Transactions Required: 1. Give the journal entries indicated for each of these transactions. (c) Issued 8,000 shares of preferred stock at $20 cash per share

61 E11-6 Recording and Reporting Stockholders’ Equity Transactions Required: 2. Prepare the stockholders’ equity section of the balance sheet at December 31, At the end of 2010, the accounts reflected net income of $36,000. No dividends were declared. 8,000 shares × ($20 – $10) (20,000 shares × $40) + (6,000 shares × ($40) 11-61

62 E11-8 Recording Treasury Stock Transactions and Analyzing Their Impact During 2010, the following selected transactions affecting stockholders’ equity occurred for Corner Corporation: Feb. 1 Purchased 400 shares of the company’s own common stock at $22 cash per share. Jul. 15 Issued 100 of the shares purchased on February 1, 2010, for $24 cash per share. Sept. 1 Issued 60 more of the shares purchased on February 1, 2010, for $20 cash per share. Required: 1. Show the effects of each transaction on the accounting equation. 2. Give the indicated journal entries for each of the transactions. 3. What impact does the purchase of treasury stock have on dividends paid? 4. What impact does the issuance of treasury stock for an amount higher than the purchase price have on net income? 11-62

63 Analyze 1 E11-8 Recording Treasury Stock Transactions and Analyzing Their Impact Required: 1. Show the effects of each transaction on the accounting equation

64 E11-8 Recording Treasury Stock Transactions and Analyzing Their Impact Required: 2. Give the indicated journal entries for each of the transactions. Record July 15 2 Record Sept. 1 2 Record Feb

65 E11-8 Recording Treasury Stock Transactions and Analyzing Their Impact Required: 3. What impact does the purchase of treasury stock have on dividends paid? 4. What impact does the issuance of treasury stock for an amount higher than the purchase price have on net income? Dividends are not paid on treasury stock. Therefore, the total amount of cash dividends paid is reduced when treasury stock is purchased. The sale of treasury stock for more or less than its original purchase price does not have an impact on net income. The transaction affects only balance sheet accounts

66 E11-11 Recording the Payment of Dividends and Preparing a Statement of Retained Earnings The 2009 annual report for Sneer Corporation disclosed that the company declared and paid preferred dividends in the amount of $119.9 million in It also declared and paid dividends on common stock in the amount of $2 per share. During 2009, Sneer had 1,000,000,000 shares of common authorized; 387,570,300 shares had been issued; 41,670,300 shares were in treasury stock. The balance in Retained Earnings was $1,554 million on December 31, 2008, and 2009 Net Income was $858 million. Required: 1. Prepare journal entries to record the declaration, and payment, of dividends on (a) preferred and (b) common stock. 2. Using the information given above, prepare a statement of retained earnings for the year ended December 31,

67 E11-11 Recording the Payment of Dividends and Preparing a Statement of Retained Earnings 1. Prepare journal entries to record the declaration, and payment, of dividends on (a) preferred and (b) common stock. a. Preferred Stock Declaration Payment 11-67

68 E11-11 Recording the Payment of Dividends and Preparing a Statement of Retained Earnings 1. Prepare journal entries to record the declaration, and payment, of dividends on (a) preferred and (b) common stock. b. Common Stock Dividends are paid on shares that are issued and outstanding. Dividends are not paid on treasury stock

69 E11-11 Recording the Payment of Dividends and Preparing a Statement of Retained Earnings 1. Prepare journal entries to record the declaration, and payment, of dividends on (a) preferred and (b) common stock. b. Common Stock Declaration Payment 11-69

70 E11-11 Recording the Payment of Dividends and Preparing a Statement of Retained Earnings 2. Using the information given above, prepare a statement of retained earnings for the year ended December 31,

71 E11-20 Determining the Effect of a Stock Repurchase on EPS and ROE Swimtech Pools Inc. (SPI) reported the following in its financial statements for the quarter ended March 31, During the quarter ended March 31, 2010, SPI reported Net Income of $5,000 and declared and paid cash dividends totaling $5,000. Required: 1. Calculate earnings per share (EPS) and return on equity (ROE) for the quarter ended March 31, Net Income Average Number of Common Shares Outstanding EPS = $5,000 50,000 Shares EPS = = $0.10 per share 11-71

72 E11-20 Determining the Effect of a Stock Repurchase on EPS and ROE Required: 1. Calculate earnings per share (EPS) and return on equity (ROE) for the quarter ended March 31, Net Income Average Stockholders’ Equity ROE = $5,000 $100,000 ROE = = 5.0 percent 11-72

73 E11-20 Determining the Effect of a Stock Repurchase on EPS and ROE Required: 2. Assume SPI repurchases 10,000 of its common stock at a price of $2 per share on April 1, Also assume that during the quarter ended June 30, 2010, SPI reported Net Income of $5,000, and declared and paid cash dividends totaling $5,000. Calculate earnings per share (EPS) and return on equity (ROE) for the quarter ended June 30, $5,000 40,000 Shares EPS = = $0.125 per share If 10,000 shares are repurchased on April 1, 2010, only 40,000 shares would be outstanding from April 1 – June 30,

74 $5,000 $80,000 ROE = = 6.25 percent 10,000 shares are repurchased for $20,000 on April 1, 2010, resulting in a Stockholders’ Equity balance of $80,000 from April 1 – June 30, E11-20 Determining the Effect of a Stock Repurchase on EPS and ROE Required: 2. Assume SPI repurchases 10,000 of its common stock at a price of $2 per share on April 1, Also assume that during the quarter ended June 30, 2010, SPI reported Net Income of $5,000, and declared and paid cash dividends totaling $5,000. Calculate earnings per share (EPS) and return on equity (ROE) for the quarter ended June 30,

75 E11-20 Determining the Effect of a Stock Repurchase on EPS and ROE Swimtech Pools Inc. (SPI) reported the following in its financial statements for the quarter ended March 31, Required: 3. Based on your calculations in requirements 1 and 2, what can you conclude about the impact of a stock repurchase on EPS and ROE? By repurchasing stock, a company can increase both its EPS and ROE

76 End of Chapter 11


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