Intermediate Accounting,17E

Intermediate Accounting,17E
Stice | Stice | Skousen Intermediate Accounting,17E Equity Financing PowerPoint presented by: Douglas Cloud Professor Emeritus of Accounting, Pepperdine University © Cengage Learning

Nature and Classifications of Paid-In Capital
A corporation is a legal artificial entity separate from its owners. Individuals contribute capital for which the corporation issues certificates making them stockholders. The board of directors is elected by the stockholders, and it is in charge of overseeing the long-run plan for the organization.

Common and Preferred Stock
When a corporation is formed, a single class of stock, known as common stock, usually is issued. Corporations may later find that there are advantages to issuing one or more additional classes of stock with varying rights and priorities. Stock with certain preferences (rights) over common stock is called preferred stock.

Common Stock Unless restricted by terms of the articles of incorporation, certain basic rights are held by each common stockholder. To vote in the election of directors and in the determination of certain corporate policies. To maintain one’s proportional interest in the corporation through purchase of additional common stock if and when it is issued. This right is known as the preemptive right.

Par or Stated Value Historically, par value was equal to the market value of the shares at issuance. Today, most stocks have a nominal par value or no par value. No-par stock sometimes has a stated value that for financial reporting purposes acts like a par value.

Preferred Stock 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—cash dividends received by preferred stockholders are usually fixed in amount. If the firm does extremely well, their dividend amount is not adjusted

Preferred Stock Rights enjoyed by preferred stockholders:
Cash dividend preference. Preferred stockholders are entitled to receive their full cash dividend before any cash dividends are paid to common stockholders. Liquidation preference. In the event of bankruptcy, preferred stockholders are entitled to have their investments repaid before common stockholders.

Cumulative and Noncumulative Preferred Stock
When a corporation fails to declare dividends on cumulative preferred stock, such dividends accumulate and require payment in the future before any dividends may be paid to common stockholders.

Good Time Corporation has outstanding 100,000 shares of 9% cumulative preferred stock, $10 par. Dividends were last paid in Total dividends of $300,000 are declared in 2011.

Dividends on cumulative preferred stock that are passed are referred to as dividends in arrears. With noncumulative preferred stock, it is not necessary to provide for passed dividends. (continues)

Dividends may be declared on common stock as long as the noncumulative preferred stock receives its preferred rate.

Participating 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 the common stockholders. A participative provision makes preferred stock more like common stock.

Convertible Preferred Stock
Preferred stock is convertible when it can be exchanged by its owner for some other security of the issuing corporation. Conversion rights generally provide for the exchange of preferred stock into common stock.

Callable Preferred Stock
Many preferred issues are callable, meaning they may be called and canceled at the option of the corporation. The call price is usually specified in the original agreement and provides for payment of dividends in arrears as part of the repurchase price.

Redeemable Preferred Stock
Redeemable preferred stock is preferred stock that is redeemable at the option of the stockholder or upon other conditions not within the control of the issuer. Redeemable preferred stock is somewhat like a loan in that the issuing corporation may be forced to repay the stock proceeds.

Capital Stock Issued for Cash
The issuance of stock for cash is recorded by a debit to Cash and a credit to Capital Stock for the par value. When the amount of cash received for the stock is more than the par value, the excess is recorded as a credit to Paid-In Capital in Excess of Par.

Par Value Stock Goode Corporation issued 4,000 shares of $1 par common stock on April 1, 2011, for $45,000 cash. Apr. 1 Cash 45,000 Common Stock 4,000 Paid-In Capital in Excess of Par 41,000 2011 (continues)

Stated Value Stock On April 1, 2011, Goode Corporation issued 4,000 shares of no-par common stock with a $1 stated value. Apr. 1 Cash 45,000 Common Stock 4,000 Paid-In Capital in Excess of Stated Value 41,000 2011 (continues)

No-Par Stock On April 1, 2011, Goode Corporation issued 4,000 shares of no-par common stock for $45,000 cash. Apr. 1 Cash 45,000 Common Stock 45,000 2011 (continues)

Capital Stock Sold on Subscription
Received subscriptions on November 1 for 5,000 shares of $1 par common stock at $12.50 per share with 50% down, balance due in 60 days. The entries for November 1 are as follows: Common Stock Subscriptions Receivable 62,500 Common Stock Subscribed 5,000 Paid-In Capital in Excess of Par 57,500 Cash 31,250 Common Stock Subscriptions Receivable 31,250 (continues)

Capital Stock Sold on Subscription
On December 31, received balance due on one-half of subscriptions and issued stock to the fully paid subscribers, 2,500 shares. Cash 15,625 Common Stock Subscriptions Receivable 15,625 Common Stock Subscribed 2,500 Common Stock 2,500

Capital 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. Land 10,000 Common Stock 100 Paid-In Capital in Excess of Par 9,900

Capital Stock Issued for Consideration Other Than Cash
The land has a readily determinable market price of $12,000, but AC Company’s common stock has no established fair market value. Land 12,000 Common Stock 100 Paid-In Capital in Excess of Par 11,900

Reasons Companies Repurchase Stock
Provide shares for incentive compensation and employee savings plans. Obtain shares needed to satisfy requests by holders of convertible securities. Reduce the amount of equity relative to the amount of debt. Invest excess cash temporarily. (continues)

Reasons Companies Repurchase Stock
Remove some shares from the open market in order to protect against a hostile takeover. Improve per-share earnings by reducing the number of shares outstanding and returning inefficiently used assets to shareholders. Display confidence that the stock is currently undervalued by the market.

Treasury Stock Treasury stock is stock issued by a corporation and subsequently reacquired by 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.

Cost Method of Accounting for Treasury Stock
2010—Newly organized corporation issued 10,000 shares of common stock, $1 par, at $15: Cash 150,000 Common Stock 10,000 Paid-In Capital in Excess of Par 140,000 2011—Reacquired 1,000 shares of common stock at $40 per share: Treasury Stock 40,000 Cash 40,000 2011—Sold 200 shares of treasury stock at $50 per share: Cash 10,000 Treasury Stock (200 × $40) 8,000 Paid-In Capital from Treasury Stock 2,000 Note: No gain is recorded on sale (continues)

Because the treasury stock is reissued at a price greater than the $40 repurchase price, the excess is recorded in an additional paid-in capital account. 2011—Sold 500 shares of treasury stock at $34 per share: Cash 17,000 Paid-In Capital from Treasury Stock 2,000 Retained Earnings 1,000 Treasury Stock (500 × $40) 20,000 Note: No loss is recorded on sale (continues)

Because the treasury stock is reissued at a price less than the $40 repurchase price, Retained Earnings is debited for the difference; any paid-in capital from prior treasury stock transactions may first be debited. 2011—Retired remaining 300 shares of treasury stock: Common Stock 300 Paid-In Capital in Excess of Par 4,200 Retained Earnings [300 × ($40 – $15)] 7,500 Treasury Stock (300 × $40) 12,000

Par (or Stated) Value Method of Accounting for Treasury Stock
2010—Newly organized corporation issued 10,000 shares of common stock, $1 par, at $15: Cash 150,000 Common Stock 10,000 Paid-In Capital in Excess of Par 140,000 2011—Reacquired 1,000 shares of common stock at $40 per share: Treasury Stock 1,000 Paid-In Capital in Excess of Par 14,000 Retained Earnings [1,000 × ($40 – $15)] 25,000 Cash 40,000 (continues)

Par (or Stated) Value Method of Accounting for Treasury Stock
2011—Sold 500 shares of treasury stock at $34 per share: Cash 17,000 Treasury Stock 500 Paid-In Capital in Excess of Par 16,500 2011—Retired remaining 300 shares of treasury stock: Common Stock 300 Treasury Stock 300

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.

Stock Rights When announcing rights to purchase additional shares of stock, the directors of a corporation specify a date on which the rights will be issued. All stockholders of record are entitled to the rights. Thus, between the announcement date and the issue date, the stock is said to sell rights-on. (continues)

Stock Rights After the rights are issued, the stock sells ex-rights, and the rights may be sold separately by those receiving them from the corporation.

Stock Warrants Detachable warrants are similar to stock rights because they can be traded separately from the security with which they were originally issued. Nondetachable warrants cannot be separated from the security with which they were issued.

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.

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

Stock Warrants The entry on Stewart’s books to record the sale of the preferred stock with detachable warrants is: Cash 58,000 Preferred Stock, $50 par 50,000 Paid-In Capital in Excess of Par— Preferred Stock 5,100 Common Stock Warrants (from Slide 13-38) 2,900

Stock Warrants If the warrants are exercised: If the warrants expire:
Common Stock Warrants 2,900 Cash 25,000 Common Stock, $2 par 2,000 Paid-In Capital in Excess of Par— Common Stock 25,900 If the warrants expire: Common Stock Warrants 2,900 Paid-In Capital from Expired Warrants 2,900

Share-Based Compensation
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 expense is allocated over three years from January 1, 2009 (the grant date) to January 1, 2012 (the vesting date). The year-end entry is as follows: Dec. 31 Compensation Expense 33,333 Paid-In Capital from Stock Options 33,333 2009 $100,000/3

Share-Based Compensation
On December 31, 2012, all 10,000 of the options are exercised to purchase Neff’s no-par common stock: Dec. 31 Cash (10,000 x $50) 500,000 Paid-In Capital from Stock Options 100,000 Common Stock (no par) 600,000 2012 If the options are allowed to expire unexercised: Dec. 31 Paid-In Capital from Stock Options 100,000 Paid-In Capital from Expired Options 100,000 2012

Accounting for Performance-Based Plans
In a performance-based stock option plan, the plan terms are dependent on how well the individual or company performs after the date the options are granted.

On January 1, 2009, the board of directors of Neff Company authorized the granting of stock options to supplement the salaries of certain employees. Each stock option permits the purchase of one share of Neff common stock at a price of $50 per share; the market price on January 1, 2009, is also $50 per share. Each option is computed to have a value of $10. (continues)

The options vest, or become exercisable, beginning on January 1, 2012, and only if the employee stays with the company for the entire 3-year period. The options expire on December 31, 2012. The number of options granted is contingent on Neff’s level of sales for If Neff sales are less than $50 million, only 10,000 options will vest. (continues)

If Neff’s 2011 sales are between $50 million and $80 million, an additional 2,000 options will vest. If Neff’s 2011 sales exceed $80 million, a total of 15,000 options will vest. Neff’s share price changed as follows over the 3-year vesting period: Jan. 1, 2009, $50; Dec. 31, 2009, $56; Dec. 31, 2010, $57; Dec. 31, 2011, $59

Recognition of compensation of $40,000 for each of the three years [(12,000 options × $10)/3]: Dec. 31 Compensation Expense 40,000 Paid-In Capital from Stock Options 40,000 2009 Sales are expected to be only $40 million, so only 10,000 options will vest on January 1, 2012: Dec. 31 Compensation Expense ($66,667 – $40,000) 26,667 Paid-In Capital from Stock Options 26,667 2010 (continues)

Actual sales for 2011 are $85 million, so 15,000 options will vest on January 1, 2012: Dec. 31 Compensation Expense ($150,000 – $66,667) 83,333 Paid-In Capital from Stock Options 83,333 2011 On December 31, 2012, all 15,000 options are exercised to purchase Neff’s no-par common stock: Dec. 31 Cash ($15,000 × $50) 750,000 Paid-In Capital from Stock Options 150,000 Common Stock (no par) 900,000 2012

Accounting for Awards That Call for Cash Settlement
Assume that Neff Company has decided instead of granting its employees 10,000 stock options, it will grant an equal number of cash stock appreciation rights (SARs). A cash SAR awards an employee a cash amount equal to the market value of the issuing firm’s shares above a specified threshold price.

Neff Company Example Neff’s share price:
January 1, 2009 $50 December 31, December 31, December 31, December 31, As of December 31, 2009, the $56 is used as the best estimate for the cash SARs. The amount of cash involved will be $60,000 [10,000 × ($56 – $50)]. (continues)

Neff Company Example Dec. 31 Compensation Expense 20,000 Share-Based Compensation Liability 20,000 2009 At the end of 2010, the stock price is $57. The new estimation for compensation expense is $70,000 [10,000 × ($57 – $50). Dec. 31 Compensation Expense ($46,667 – $20,000) 26,667 Share-Based Compensation Liability 26,667 2010 (continues)

Neff Company Example Neff’s stock price is $59 at the end of Aggregate compensation expense is $90,000 [10,000 × ($59 – $50)]. Of this amount, $46,667 has already been recognized. Dec. 31 Compensation Expense ($90,000 ─ $46,667) 43,333 Share-Based Compensation Liability 43,333 2011 (continues)

Neff Company Example By the end of 2012, the price of Neff’s stock is $61. An entry is required to reflect this increase in stock value [10,000 × ($61 – $59). Dec. 31 Compensation Expense 20,000 Share-Based Compensation Liability 20,000 2012 Cash payments are made to the holders of the 10,000 SARs on December 31, 2012. Dec. 31 Share-Based Compensation Liability 110,000 Cash [10,000 × ($61 – $50)] 110,000 2012

Mandatorily Redeemable Preferred Shares
Historically, the SEC required that firms not include mandatorily redeemable preferred stock under the Stockholders’ Equity heading. Given a “mezzanine” treatment. FASB Statement No. 150 requires these items to be reported as liabilities in the balance sheet.

Written Put Options A put option is an agreement that allows investors to sell the issuing corporation shares they hold at set prices on specific dates. If the stock price stays above a set level per share, the issuing corporation pays nothing. Historically recorded as part of equity. (continues)

Written Put Options In Statement No.150, the FASB instructs companies to record the fair value of the obligation under written put options on a company’s own shares as a liability.

Obligation to Issue Shares of a Certain Dollar Value
Companies occasionally agree to satisfy their obligations by delivering shares of their own stock rather than by paying cash. This is especially true for startup companies. Can be recorded as equity or as a liability, depending on how the contract is written.

Noncontrolling Interest
When a parent company owns less than 100% of the subsidiary’s assets and liabilities, there are minority stockholders. Financing provided by minority stockholders is called minority interest. Under SFAS No. 160, the FASB uses the term noncontrolling interest.

Stock Conversions Case 1
On December 31, 2011, 1,000 shares of preferred stock (par $50) are exchanged for 4,000 shares of common stock (par $1). Dec. 31 Preferred Stock, $50 par 50,000 Paid-In Capital in Excess of Par— Preferred 10,000 Common Stock, $1 par 4,000 Paid-In Capital in Excess of Par—Common 56,000 2011

Stock Conversions Case 2
On December 31, 2011, 1,000 shares of preferred stock (par $50) are exchanged for 4,000 shares of common stock (par $20). Dec. 31 Preferred Stock, $50 par 50,000 Paid-In Capital in Excess of Par— Preferred 10,000 Retained Earnings 20,000 Common Stock, $20 par 80,000 2011

Factors Affecting Retained Earnings

Net Income and Dividends
The primary source of retained earnings is the net income generated by a business. When operating losses or other debits to Retained Earnings produce a debit balance in the account, the debit balance is referred to as a deficit. Use of the term dividends without qualification normally implies the distribution of cash.

Prior-Period Adjustments
In some situations, errors made in past years are discovered and corrected in the current year by an adjustment to Retained Earnings, referred to as a prior-period adjustment.

Accounting for Dividends
In setting dividend policy, the board of directors must answer two questions: Do we have the legal right to declare a dividend? Is a dividend distribution financially advisable?

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

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

Property Dividends A property dividend is a distribution to stockholders that is payable in some asset other than cash. Bigler 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 Bigler stock outstanding. A dividend of 1/10 of a share of Tri-State Oil Co. is declared for each share of Bigler stock outstanding.

Property Dividends Declaration of Dividend: Payment of Dividend:
Dividends (or Retained Earnings) 3,000,000 Property Dividends Payable 2,700,000 Gain on Distribution of Property Dividends 300,000 Payment of Dividend: Property Dividends Payable 2,700,000 Investment in Tri-State Oil Co. Stock 2,700,000

Stock Dividends Small: Less than 20–25% of the outstanding shares.
Debit Retained Earnings for the market value of the shares. Large: Greater than 20–25% of the shares outstanding. Debit Retained Earnings for the par value of the shares.

Small Dividend Example
The stockholders’ equity section for the Fuji Company on July 1 is as follows: Common Stock, $1 par, 100,000 shares outstanding $ 100,000 Paid-In Capital in Excess of Par 1,100,000 Retained Earnings 750,000 The company declares a 10% stock dividend. Before the stock dividend, the stock is selling for $22 per share. After the stock dividend, each original share sells for $20. (continues)

Small Dividend Example
Declaration of Dividend: Retained Earnings 200,000 Stock Dividends Distributable 10,000 Paid-In Capital in Excess of Par 190,000 Payment of Dividend: Stock Dividends Distributable 10,000 Common Stock, $1 par 10,000

Large Dividend Example
The stockholders’ equity section for the Fuji Company on July 1 is as follows: Common Stock, $1 par, 100,000 shares outstanding $ 100,000 Paid-In Capital in Excess of Par 1,100,000 Retained Earnings 750,000 The company declares a 50% stock dividend. Before the stock dividend, the stock is selling for $22 per share. (continues)

Large Dividend Example
Declaration of Dividend: Retained Earnings 50,000 Stock Dividends Distributable 50,000 OR Paid-In Capital in Excess of Par 50,000 Payment of Dividend: Stock Dividends Distributable 50,000 Common Stock, $1 par 50,000

Stock Dividends versus Stock Splits
A corporation may effect a stock split by reducing the par or stated value of each share of capital stock and proportionately increasing the number of shares outstanding. A stock dividend results in an increase in the number of shares outstanding. The par or stated value remains unchanged. A stock split divides the existing Capital Stock balance into more parts, with a reduction in par or stated value of each share.

Liquidating Dividends
A liquidating dividend is a distribution representing a return to stockholders of a portion of contribution capital. Example: Stubbs Corporation declared and paid a cash dividend ($10 cash dividend) totaling $100,000 and a partial liquidating dividend of $50,000.

Foreign Currency Translation Adjustment
The foreign currency translation adjustment arises from the change in the equity of foreign subsidiaries (as measured in terms of U.S. dollars) that occurs as a result of changes in foreign currency exchange rates. These changes are recorded as direct adjustments to equity.

Unrealized Gains and Losses on Available-for-Sale Securities
Available-for-sale securities are those that were not purchased with immediate intention to resell, but that a company also doesn’t necessarily plan to hold forever. Reported on the balance sheet at their current market value.

Unrealized Gains and Losses on Derivatives
A derivative is a financial instrument, such as an option or a future, that derives its value from the movement of a price, an exchange rate, or an interest rate associated with some other item. Derivatives are used to manage risk associated with sales or purchases that will not occur until a future period.

International Accounting: Equity Reserves
In foreign countries, the payment of cash dividends is linked to the amount of distributable equity. Equity is divided among various equity reserve accounts, each with legal restrictions dictating whether it can be distributed to stockholders.

International Accounting
Capital stock may be: 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

Intermediate Accounting,17E

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