Introduction to Using Financial Accounting Information, 7/e Stockholders’ Equity Statements and the Annual Report 11 PowerPoint Author: Catherine Lumbattis COPYRIGHT © 2011 South-Western/Cengage Learning

Advantages of Stock vs. Debt Financing Flexibility Exchanges facilitates trading Return on investment Disadvantages Advantages LO1

Disadvantages of Stock vs. Debt Financing Control Tax consequences Impact on ratios Disadvantages Advantages

Expanded Accounting Equation Assets = Liabilities + Owners’ Equity Assets = Liabilities + Stockholders’ Equity Contributed Capital Retained Earnings

Retained Earnings Connects the Income Statement and Balance Sheet Revenues $ xxx Less: Expenses xxx Net Income $ Net Inc Statement of Retained Earnings Retained Earnings, Beginning Balance $ xxx Add: Net Income inc Deduct: Dividends xxx Retained Earnings, Ending Balance $ end Balance Sheet Total Assets $ xxx Total Liabilities $ xxx Stockholders’ Equity xxx Retained Earnings end Total Liabilities and Stockholders' Equity $ xxx

Contributed Capital Common Stock Basic stock of corporation Normally carries voting rights Preferred Stock Optional Tailored to meet specific needs

Par Value “Legal capital” Arbitrary amount stated on stock certificate Also called “stated value”

Additional Paid-in Capital Amount received in excess of par when stock was originally issued

Retained Earnings Net income retained in the business (not paid out as dividends) since its inception Reinvested in a variety of assets (not necessarily liquid or cash)

IFRS and Stockholders’ Equity International standards differ from U.S. standards for those items that have attributes of both debt and equity Convertible stock must be separated into a part that is presented in the Liability section and another part that is presented as Stockholders’ Equity section of the Balance Sheet

Preferred Stock Can tailor to specific needs of firm Stated dividend rate Percentage of the stock’s par value Per-share amount Often carries dividend preference over common stock LO2

Stock Issued for Cash Example: Common Stock $ 10,000 1,000 shares of $10 par value stock sold for $15 per share Common Stock $ 10,000 ( $10 par value × 1,000 shares) Additional Paid-In Capital $5,000 (($15 – $10) × 1,000 shares) Example: LO3

Recording Issuance of Stock

Stock Issued for Noncash Consideration Record at fair market value of consideration given or received, whichever is more readily determinable Building Common or Preferred Stock

Treasury Stock Company buys back its own stock Contra-equity account (debit balance) Not outstanding (no voting rights) LO4

Presentation of Treasury Stock Common stock, $10 par value, 1,000 shares issued, 900 outstanding $10,000 Additional paid-in capital—Common 12,000 Retained earnings 15,000 Total contributed capital and retained earnings 37,000 Less: Treasury stock, 100 shares at cost ($25 per share) 2,500 Total stockholders’ equity $34,500

Retirement of Stock Repurchase of stock and is not intended to be resold A proportional amount of the related Stock and Paid-In Capital accounts must be eliminated

Cash Dividends Paid to on Date of declaration Stockholders on date of record Payment date LO 5

Dividend Requirements Sufficient cash Positive retained earnings

Annual Dividend Amount Dividend Payout Ratio Annual Dividend Amount Annual Net Income The % of earnings paid as dividends

Dividends (1) dividends declared (2) dividends paid 12/31/10 1/15/11 Journal entry required to record: (1) dividends declared (2) dividends paid 12/31/10 1/15/11 Reduce retained earnings Pay dividends

Recording Cash Dividends Declare a dividend: Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenues – Expenses = Net Equity Income Dividends Retained Payable Earnings Payment of Dividend: Cash Dividend Payable

Allocation of Common and Preferred Cash Dividends Distribute dividends in arrears, if any, to preferred Distribute current year’s dividends to preferred Distribute remainder to common (or to both if preferred is participating)

Stock Dividends Issue of additional shares proportionately to existing stockholders Reasons: Insufficient cash Market price reduction Nontaxable to recipients LO6

Small Stock Dividend Example Stockholders’ Equity: Common stock, $10 par, 5,000 shares issued and outstanding $ 50,000 Additional paid-in capital—Common 30,000 Retained earnings 70,000 Total stockholders’ equity $150,000 Before Dividend Assume Shah Company declares a 10% stock dividend; 500 shares @ $40 per share market value

Small Stock Dividend Example Stockholders’ Equity: Common stock, $10 par, 5,500 shares $ 50,000 $ 55,000 Additional paid-in capital—Common 30,000 45,000 Retained earnings 70,000 50,000 Total stockholders’ equity $150,000 $150,000 Before After + + – $40 market value deducted from retained earnings; allocated between Common Stock (initially Common Stock Dividend Distributable) and Additional Paid-In Capital.

Large Stock Dividend Example Stockholders’ Equity: Common stock, $10 par, 5,000 shares issued and outstanding $ 50,000 Additional paid-in capital—Common 30,000 Retained earnings 70,000 Total stockholders’ equity $150,000 Before Dividend Assume Shah Company declares 100% stock dividend

Large Stock Dividend Example Stockholders’ Equity: Common stock, $10 par, 10,000 shares $ 50,000 $100,000 Additional paid-in capital—Common 30,000 30,000 Retained earnings 70,000 20,000 Total stockholders’ equity $150,000 $150,000 Before After + – Dividend deducted from retained earnings and recorded in the Common Stock account at par. Additional Paid-In Capital account is unaffected.

Stock Splits Results in additional issuance of shares Reduces par value per share No change in Stockholders’ Equity accounts LO 7

Stock Splits Not recorded in accounts Reduce market price per share and make the stock more accessible to a wider range of investors Disclosed in notes

2-for-1 Stock Split Example Stockholders’ Equity: Common stock, $10 par, 5,000 shares issued and outstanding $ 50,000 Additional paid-in capital—Common 30,000 Retained earnings 70,000 Total stockholders’ equity $150,000 Before Split Assume Shah Company declares 2-for-1 stock split

2-for-1 Stock Split Example Before After Stockholders’ Equity: Common stock, $5 par, 10,000 shares $ 50,000 $ 50,000 Additional paid-in capital—Common 30,000 30,000 Retained earnings 70,000 70,000 Total stockholders’ equity $150,000 $150,000 All accounts are unchanged Only disclosures are affected

Statement of Stockholders’ Equity Explains all the reasons for the difference between the beginning and the ending balance of each of the accounts in the Stockholders’ Equity category of the balance sheet Statement of Retained Earnings Beginning retained earnings Add: Net earnings Subtract: Dividend(s) declared = Ending retained earnings LO8

Statement of Comprehensive Income For Year Ended December 31, 20XX Net income xxx Foreign currency translation adjustment xxx Unrealized holding gains/losses xxx Minimum pension liability adjustment xxx Other comprehensive income xxx Comprehensive income xxx Income Statement For Year Ended December 31, 20XX Revenues xxx Expenses xxx Other gains and losses xxx Income before tax xxx Income tax expense xxx Net income xxx Comprehensive income – the total change in net assets from all sources except investments by or distributions to the owners

Analyzing Owners’ Equity Book value per share Rights that each share of common stock has to the net assets of corporation Market value per share Price at which stock is currently selling LO9

Total Stockholders’ Equity Number of Shares of Stock Outstanding Book Value per Share Total Stockholders’ Equity Number of Shares of Stock Outstanding Amount per share of net assets to which the company’s common stockholders have the rights Does not indicate the price that should be paid by those who want to buy or sell the stock on the stock exchange

Market Value per Share The selling price of the stock as indicated by the most recent transactions Usually stated in a 52-week high and low More meaningful measure of the value of the stock than book value 52-week Daily High Low Sym High Low Last Change 68.17 39.17 GM 43.3 42.01 42.93 +0.48 (1.13%)

Stockholders’ Equity Items on the Statement of Cash Flows Operating Activities Net income xxx Investing Activities Financing Activities Issuance of stock + Retirement or repurchase of stock – Payment of dividends – LO10

Unincorporated Businesses Appendix Accounting Tools: Unincorporated Businesses

Sole Proprietorships Not a separate legal entity so owner has unlimited liability Must keep personal and business records separate Business income is declared on the owner’s personal tax return and taxed at personal tax rate LO11

Owners’ drawing or withdrawal accounts are contra-equity accounts Sole Proprietorship Owner withdraws an auto from business: Owners’ drawing or withdrawal accounts are contra-equity accounts

Sole Proprietorships Drawing or withdrawal and income summary accounts are closed to the owner’s capital account Owner’s Equity section of the balance sheet consists of the capital account: Beginning balance $ 0 Plus: Investments 10,000 Net Income 4,000 Less: Withdrawals (6,000) Ending balance $ 8,000

Partnerships Unlimited liability Limited life – partnership agreements can and do end Not taxed as a separate entity

Partnerships Distribution of income: Equal distribution Stated ratio Other allocation For example, based on salaries, interest on invested capital, and a stated ratio

End of Chapter 11