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1 Equity Financing - Learning Objectives 1. Identify the rights associated with ownership of common and preferred stock. 2.Record the issuance of stock.

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Presentation on theme: "1 Equity Financing - Learning Objectives 1. Identify the rights associated with ownership of common and preferred stock. 2.Record the issuance of stock."— Presentation transcript:

1 1 Equity Financing - Learning Objectives 1. Identify the rights associated with ownership of common and preferred stock. 2.Record the issuance of stock for cash, on a subscription basis, and in exchange for noncash assets or for services. 3.Use both the cost and par value methods to account for stock repurchases. 4. Account for the issuance of stock rights and stock warrants. 5. Explain the difference between the intrinsic value and fair value methods, and use both in accounting for a fixed stock option plan. 6.Distinguish between stock conversions that require a reduction in retained earnings and those that do not. 7.List the factors that impact the retained earnings balance.

2 2 Learning Objectives 8. Properly record cash dividends, property dividends, small and large stock dividends, and stock splits. 9. Explain the background of unrealized gains and losses recorded as direct equity adjustments, and list the major types of equity reserves founds in foreign balance sheets. 10.Prepare a statement of changes in stockholders’ equity.

3 3 Common Stock The owners of common stock of a corporation can be thought of as the true owners of the business. Unless restricted by terms of the articles of incorporation, the common stockholder has certain basic rights.

4 4  The right to vote in the election of directors and in the determination of certain corporate polices such as the management compensation plan or major corporate acquisitions.  The right to maintain one’s proportional interest in the corporation through purchase of additional common stock if and when it is issued. Common Stock

5 5 Rex Corporation issued 5,000 shares of common stock with a par value of $1 on April 1, 2005, for $30,000 cash. Apr. 1Cash30,000 Common Stock5,000 Additional Paid-In Capital25,000 Common Stock at Par Value

6 6 Preferred Stock The title “preferred” stock is somewhat misleading. Preferred isn’t better; it’s different.

7 7 Preferred Stock The rights of ownership given up by preferred stockholders: Voting: In most cases, preferred stockholders are not allowed to vote for the board of directors. Sharing in success: The cash dividends received by preferred stockholders are usually fixed in amount. If the company does exceptionally well, preferred stockholders do not get to share in the success.

8 8 Cash dividend preference: Preferred stockholders are entitled to receive their full cash dividend before any cash dividend can be issued to common stockholders. Liquidation preference: If the company goes bankrupt, preferred stockholders are entitled to have their investment repaid in full, before common stockholders receive anything. The protection enjoyed by preferred stockholders is: Preferred Stock

9 9 Cumulative Has the right to receive accumulated dividends before any dividends may be paid to common stockholders. Non- Cumulative Has no right to “passed” dividends. Participating Has claim to a portion of common dividends after receiving preferred dividends. Preferred Stock

10 10 Callable Permits the issuing company to redeem the preferred stock. Redeemable Permits the holder to redeem the stock—usually with some restrictions. Convertible Permits the holder to exchange preferred stock for common stock. Preferred Stock

11 11 Preferred Stock Dividends on cumulative preferred stock that are passed are referred to as dividends in arrears. And… dividends are not a liability until declared by the board of directors.

12 12 Preferred Stock Participating preferred stock issues provide for additional dividends to be paid to preferred stockholders after dividends of a specified amount are paid to common stockholders. Callable preferred stock is preferred stock that is redeemable at the option of the corporation. Redeemable preferred stock is preferred stock that is redeemable at the option of the stockholder.

13 13 Capital Stock Issued for Cash Goode Corporation issued 4,000 shares of $1 par common stock on April 1, 2005, for $45,000 cash. Apr. 1Cash45,000 Common Stock4,000 Paid-In Capital in Excess of Par41,000

14 14 On April 1, 2005, Goode Corporation issued 4,000 shares of no-par common stock without a stated value for $45,000 cash. Apr. 1Cash45,000 Common Stock45,000 Capital Stock Issued for Cash

15 15 Capital Stock Sold on Subscription On November 1, 2005, a firm received subscriptions for 5,000 shares of $1 par common at $12.50 per share with 50% down, balance due in 60 days. Nov. 1Common Stock Subscription Receivable62,500 Common Stock Subscribed5,000 Paid-In Capital in Excess of Par57,500

16 16 Capital Stock Sold on Subscription On November 1, 2005, a firm received subscriptions for 5,000 shares of $1 par common at $12.50 per share with 50% down, balance due in 60 days. Nov. 1Cash31,250 Common Stock Subscription Receivable31,250

17 17 Capital Stock Sold on Subscription On December 9, received balance due on one-half of subscribers and issued stock to fully paid subscribers, 2,500 shares. Dec. 9 Cash15,625 Common Stock Subscription Receivable15,625 9 Common stock Subscribed2,500 Common Stock2,500

18 18 Stock Issued for Consideration Other Than Cash AC Company issues 200 shares of $0.50 par value common stock in return for land. The company’s stock is currently selling for $50 per share. Dec. 5 Land10,000 Common Stock 100 Paid-In Capital in Excess of Par9,900

19 19 Stock Issued for Consideration Other Than Cash Assume that the land has a readily determinable market price of $12,000, but AC Company’s common stock has no established fair market value. Dec. 5 Land12,000 Common Stock 100 Paid-In Capital in Excess of Par11,900

20 20 Stock Repurchases 1. Provide shares for incentive compensation and employee savings plans. 2.Obtain shares needed to satisfy requests by holders of convertible securities. 3. Reduce the amount of equity relative to the amount of debt. 4. Invest excess cash temporarily. Remove some shares from the open market in order to protect against a hostile takeover. 6.Improve per-share earnings by reducing the number of shares outstanding and returning inefficiently used assets to shareholders. 7.Display confidence that the stock is currently undervalued by the market. Companies acquired their own stock to…

21 21 Treasury Stock Stock issued by a corporation but subsequently reacquired by and held in the name of the corporation and held for possible future reissuance or retirement. Reported as a contra-equity account, not as an asset. Does not create a gain or loss on reacquisition, reissuance, or retirement. May decrease Retained Earnings, but cannot increase it. There are two methods to account for treasury stock transactions: (1) Cost method and (2) Par value method

22 22 Issued 10,000, $1 par value shares at $15 per share Cost Method Cash 150,000 Common Stock. 10,000 Paid-In Capital in Excess of Par 140,000 Treasury Stock Cash 150,000 Common Stock. 10,000 Paid-In Capital in Excess of Par 140,000 Par Value Method

23 23 Reacquired 1,000 shares at $40 per share. Treasury Stock Cost Method Treasury Stock40,000 Cash40,000 Treasury Stock 1,000 Paid-In Capital in Excess of Par14,000 Retained Earnings25,000 Cash 40,000 Par Value Method The balance

24 24 Sold 200 shares of treasury stock at $50 per share. Treasury Stock Cost Method Cash10,000 Treasury Stock8,000 Paid-In Capital from Treasury Stock2,000 Cash 10,000 Treasury Stock200 Paid-In Capital in Excess of Par9,800 Par Value Method

25 25 Sold 500 shares of treasury stock at $34 per share. Treasury Stock Cost Method Cash17,000 Paid-In Capital from Treasury Stock2,000 Retained Earnings1,000 Treasury Stock20,000 Cash 17,000 Treasury Stock500 Paid-In Capital in Excess of Par16,500 Par Value Method

26 26 Retired remaining 300 shares of treasury stock. Treasury Stock Cost Method Common Stock300 Paid-In Capital in Excess of Par4,200 Retained Earnings7,500 Treasury Stock12,000 Common Stock 300 Treasury Stock300 Par Value Method

27 27 Stock Rights, Warrants, and Options Stock rights—Issued to existing shareholders to permit them to maintain their proportionate ownership interests when new shares are to be issued. Stock warrants—Sold by the corporation for cash, generally in conjunction with the issuance of another security. Stock options—Granted to officers or employees, usually as part of a compensation plan.

28 28 Stock Warrants Stewart Co. sells 1,000 shares of $50 par preferred stock for $58 per share. Stewart Co. gives the purchaser detachable warrants enabling the holders to subscribe to 1,000 shares of $2 par common stock for $25 per share. Immediately following the issuance of the stock, the warrants are selling for $3, and the fair market value of a preferred share without the warrant attached is $57.

29 29 Stock Warrants Value assigned to warrants = Total issue price x Market value of warrants Market value of security without warrants + Market value of warrants $57 + $3 Value assigned to warrants = $58,000 x $3 = $2,900

30 30 Stock Warrants The entry on Stewart’s book to record the sale of the preferred stock with detachable warrants is: Cash58,000 Preferred Stock, $50 par 50,000 Paid-In Capital in Excess of Par--Preferred Stock5,100 Common Stock Warrants2,900

31 31 Stock Warrants If the warrants are exercised, the entry to record the issuance of common stock is: Common Stock Warrants2,900 Cash25,000 Common Stock, $2 par 2,000 Paid-In Capital in Excess of Par—Common Stock25,900

32 32 Stock Warrants If these warrants were allowed to expired, what entry would be required? Common Stock Warrants2,900 Paid-In Capital from Expired Warrants2,900

33 33 Stock-Based Compensation On January 1, 2003, the board of directors of Neff Company authorize the grant of 10,000 stock options. Each option permits the purchase of one share of Neff common stock at $50 per share. The options vest or becomes exercisable on Jan 1, 2006.

34 34 Stock-Based Compensation On January 1, 2003, the board of directors of Neff Company authorize the grant of 10,000 stock options. Each option permits the purchase of one share of Neff common stock at $50 per share. The company estimates a grant date value of $10 for each of the employee stock options. The total fair value of the options granted is $100,000. Compensation cost is allocated over three years from January 1, 2003 (the grant date) to January 1, 2006 (the vesting date).

35 35 Stock-Based Compensation (Fair Value Method)* Dec. 31Compensation Expense33,333 Paid-In Capital from Stock Options33, $100,000 ÷ 3 Similar Similar entries would be made in 2004 and * There is also the Intrinsic Value Method, in which case these entries would not be made.

36 36 Dec. 31Cash500,000 Paid-In Capital from Stock Options100,000 Common Stock (no par)600, On December 31, 2006, all 10,000 of the options are exercised to purchase Neff’s no- par common stock. Stock-Based Compensation (Fair Value Method)* * Under the intrinsic value method, the entry would have been: Dec. 31Cash500,000 Common Stock (no par) 500,

37 37 Dec. 31Paid-In Capital from Stock Options100,000 Paid-In Capital from Expired Options100, If the options had been allowed to expired, the following entry would have been necessary on December 31, 2006: Stock-Based Compensation (Fair Value Method)* * The entry would have been the same under the Intrinsic Value Method.

38 38 Stock Conversions Dec. 31Preferred Stock, $50 par50,000 Paid-In Capital in Excess of Par—Preferred10,000 Common Stock4,000 Paid-In Capital in Excess of Par—Common56, On December 31, 2005, 1,000 shares of preferred stock (par $50 and original selling price of $60) are exchanged for 4,000 shares of common stock (par $1) Case 1

39 39 Stock Conversions Dec. 31Preferred Stock, $50 par50,000 Paid-In Capital in Excess of Par—Preferred10,000 Retained Earnings20,000 Common Stock80, On December 31, 2005, 1,000 shares of preferred stock (par $50 and original selling price of $60) are exchanged for 4,000 shares of common stock (par $20) Case 2

40 40 Accounting for Dividends Declaration date: The date the corporation’s board of directors formally declares a dividend will be paid. Date of record: The date on which stockholders of record are identified as those who will receive a dividend. Date of payment: The date when the dividend is actually distributed to stockholders.

41 41 Cash Dividend ABC Corporation declares a $100,000 dividend; the following journal entries should be made: Declaration Date Dividends (or Retained Earnings) 100,000 Dividends Payable100,000 Payment Date Dividends Payable100,000 Cash100,000

42 42 Property Dividend It is a distribution to stockholders that is payable in some asset other than cash.

43 43 Property Dividend Bigley Corporation owns 100,000 shares in Tri-State Oil Co, carrying value $2,700,000, current market value $3,000,000, or $30 per share. There are 1,000,000 shares of Bigley stock outstanding. A dividend of 1/10 of a share of Tri-State Oil Co. is declared for each share of Bigley stock outstanding.

44 44 Declaration of Dividend Dividend (or Retained Earnings)3,000,000 Property Dividends Payable2,700,000 Gain on Distribution of Property Dividend300,000 Property Dividend Payment of Dividend Property Dividends Payable2,700,000 Investment in Tri-State Oil Co.2,700,000

45 45 Stock Dividends Small –Less than 20-25% of the outstanding shares. –Debit Retained Earnings for the (post) MARKET value of the shares. Large –Greater than 20-25% of the shares outstanding. –Debit Retained Earnings for the PAR value of the shares.

46 46 Assume the following about Gean, Inc.: –Common stock ($2 par, 10,000 shares outstanding) $20,000 –Additional paid-in capital $24,200 –Retained earnings $12,500 –Stock dividend declared 1,500 shares –Market price of stock $10/share Assume the following about Gean, Inc.: –Common stock ($2 par, 10,000 shares outstanding) $20,000 –Additional paid-in capital $24,200 –Retained earnings $12,500 –Stock dividend declared 1,500 shares –Market price of stock $10/share Example 1: Stock Dividend Is this a large or small stock dividend?..Because 1,500 shares represent 15% of the outstanding stock, it is a small stock dividend.

47 47 Declaration Date Retained Earnings15,000 Stock Dividends Distributable 3,000 Paid-In Capital in Excess of Par12,000 Example 1: Stock Dividend Issuance Date Stock Dividends Distributable3,000 Common Stock3,000

48 48 Example 2: Stock Dividend Assume the following about Gimli’s Corp.: –Common Stock ($5 par, 20,000 shares outstanding) $100,000 –Additional Paid-In Capital $100,000 –Retained Earnings $52,000 –Stock Dividend Declared10,000 shares –Market Price of Stock $20/share Assume the following about Gimli’s Corp.: –Common Stock ($5 par, 20,000 shares outstanding) $100,000 –Additional Paid-In Capital $100,000 –Retained Earnings $52,000 –Stock Dividend Declared10,000 shares –Market Price of Stock $20/share Is this a large or small stock dividend? 50% = large dividend

49 49 Example 2: Stock Dividend Declaration Date Retained Earnings50,000 Stock Dividends Distributable50,000 Issuance Date Stock Dividends Distributable50,000 Common Stock50,000

50 50 Unrealized Gains and Losses on Available-For-Sale Securities Available-for-sale securities are those that were not purchased with the immediate intention to resell… …but the company also doesn’t necessarily plan to hold these securities forever.

51 51 The impact of other income-related equity items Kendell had net income of $1,350. Other items that impacted net income are: Unrealized gain (loss) on available- for-sale securities$100 (Increase) Decrease in minimum pension liability(60) Unrealized gain (loss) on derivative instruments(20) Foreign currency translation adjustment, increase (decrease) in stockholders’ equity300

52 52 Unrealized Gains and Losses on Available-For-Sale Securities Net income$1,350 Other comprehensive income: Unrealized gain on available-for- sale securities60 Increase in minimum pension liability(36) Unrealized loss on derivative instruments(12) Foreign current transaction adjustments 180 Comprehensive income$1,542

53 53 Liquidating Dividend A liquidating dividend is a distribution representing a return to stockholders of a portion of contributed capital. See page 672 of text. A liquidating dividend is a distribution representing a return to stockholders of a portion of contributed capital. See page 672 of text.

54 54 Disclosures Related to the Equity Section Authorized but unissued. Subscribed for and held for issuance pending receipt of cash for the full amount of the subscription price. Outstanding in the hands of stockholders. Reacquired and held by the corporation for subsequent reissuance. Canceled by appropriate corporate action. Capital stock may be:


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