Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Reporting and Interpreting Owners’ Equity Chapter 11

11-2 Learning Objectives Explain the role of stock in the capital structure of a corporation.

11-3 Understanding The Business Advantages of a corporation Simple to become an owner Easy to transfer ownership Provides limited liability

11-4 Because a corporation is a separate legal entity, it can... Own assets. Sue and be sued. Incur liabilities. Enter into contracts. Understanding The Business

11-5 Ownership of a Corporation  Voting (in person or by proxy).  Proportionate distributions of profits.  Proportionate distributions of assets in a liquidation. Rights Stockholders’

11-6 Elected by shareholders Appointed by directors Ownership of a Corporation

11-7 Authorized, Issued, and Outstanding Capital Stock The maximum number of shares of capital stock that can be sold to the public. Authorized Shares

11-8 Authorized Shares Issued shares are authorized shares of stock that have been sold. Unissued shares are authorized shares of stock that never have been sold. Authorized, Issued, and Outstanding Capital Stock

11-9 Authorized Shares 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, Issued, and Outstanding Capital Stock

11-10 Learning Objectives Analyze the earnings per share ratio.

11-11 Earnings per share (EPS) Net Income Average Number of Shares Outstanding EPS = Outback’s income for 2003 is $170,000,000 and the average number of shares outstanding is 75,260,000. Earnings per share is probably the single most widely watched financial ratio.

11-12 Net Income Average Number of Shares Outstanding EPS = $170,000,000 75,260,000 Shares EPS = = $2.26 per share Earnings per share (EPS) Earnings per share is probably the single most widely watched financial ratio.

11-13 Earnings per share (EPS) Earnings per share is probably the single most widely watched financial ratio.

11-14 Learning Objectives Describe the characteristics of common stock and analyze transactions affecting common stock.

11-15 Types of Capital Stock Common Stock Preferred Stock

11-16 Common Stock Basic voting stock Ranks after preferred stock Dividend set by board of directors

11-17 Par Value and No-par Value Stock Legal capital is the amount of capital, required by the state, that must remain invested in the business. Par Value Nominal value Legal capital

11-18 Par Value Market Value  I get it! Par Value and No-par Value Stock

11-19 No-par Value Stock Some states do not require that a par value be stated in the charter. Some states do not require a par value to be stated in the charter.

11-20 Accounting for Capital Stock Two primary sources of stockholders’ equity Retained earnings Contributed capital Common stock, par value Capital in excess of par value

11-21 Sale and Issuance of Capital Stock Initial public offering (IPO) Seasoned new issue The first time a corporation sells stock to the public. Subsequent sales of new stock to the public. Outback issues new stock. Outback

11-22 Secondary Markets Transactions between two investors that do not affect the corporation’s accounting records. I’d like to sell some of my Outback stock. I’d like to buy some of your Outback stock.

11-23 Sale and Issuance of Capital Stock Prepare the journal entry to record this transaction. On July 6, Outback issued 100,000 shares of $0.01 par value common stock for $22 per share.

,000 shares × $22 per share = $2,200, ,000 shares × $0.01 par value = $1,000 Sale and Issuance of Capital Stock On July 6, Outback issued 100,000 shares of $0.01 par value common stock for $22 per share.

11-25 Stock Options Employee Employee compensation package includes salary and stock options. Stock options allow employees to purchase stock from the corporation at a fraction of the stock’s value in the secondary market. If Outback does not have new stock to issue when the stock options are exercised, then.. Outback

11-26 Treasury Stock Outback buys its own stock in the secondary market. (Treasury stock) Stockholders Management compensation package includes salary and stock options. Stock options allow management to purchase stock from the corporation at a fraction of the stock’s value in the secondary market. Outback Management

11-27 Treasury Stock No voting or dividend rights Contra equity account When stock is reacquired, the corporation records the treasury stock at cost.

11-28 On May 1, Outback reacquired 100,000 shares of its common stock at $20 per share. The journal entry for May 1 is.... Treasury Stock

,000 shares × $30 = $300,000 10,000 shares × $20 cost = $200,000 On December 3, Outback reissued 10,000 shares of the treasury stock at $30 per share. The journal entry for December 3 is... Treasury Stock

11-30 Learning Objectives Discuss dividends and analyze transactions.

11-31 Accounting for Cash Dividends Declared by board of directors. Not legally required. Creates liability at declaration. Requires sufficient Retained Earnings and Cash.

11-32 Dividend Dates Declaration date  Board of directors declares the dividend.  Record a liability.

11-33 X Date of Record  Stockholders holding shares on this date will receive the dividend. (No entry) Dividend Dates

11-34 Date of Payment  Record the dividend payment to stockholders. Dividend Dates

11-35 Learning Objectives Analyze the dividend yield ratio.

11-36 Dividend Yield Ratio Dividend Yield Dividends Per Share Market Price Per Share = Outback paid a dividend of $0.12 per share in 2003 and the market price was $40 per share. This ratio is often used to compare the dividend-paying performance of different investment alternatives.

11-37 Dividend Yield Dividends Per Share Market Price Per Share = Dividend Yield $0.12 $40.00 = = 0.3% Dividend Yield Ratio This ratio is often used to compare the dividend-paying performance of different investment alternatives.

11-38 Dividend Yield Ratio This ratio is often used to compare the dividend-paying performance of different investment alternatives.

11-39 Learning Objectives Discuss the purpose of stock dividends, stock splits, and report transactions.

11-40 Accounting for Stock Dividends Distribution of additional shares of stock to stockholders. No change in total stockholders’ equity. All stockholders retain same percentage ownership. No change in par values.

11-41 Stock dividend < 25% Stock dividend > 25% Record at current market value of stock. Record at par value of stock. SmallLarge Accounting for Stock Dividends

11-42 Stock splits change the par value per share, but the total par value is unchanged. Ice Cream Parlor Banana Splits On Sale Now Stock Splits

11-43 Assume that a corporation had 3,000 shares of $2 par value common stock outstanding before a 2–for–1 stock split. Stock Splits

11-44 Increase Decrease No Change Stock Splits Assume that a corporation had 3,000 shares of $2 par value common stock outstanding before a 2–for–1 stock split.

11-45 Learning Objectives Describe the purpose of preferred stock and analyze transactions affecting preferred stock.

11-46 Preferred Stock Preference over common stock Usually has no voting rights Usually has a fixed dividend rate

11-47  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.  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. Dividends on Preferred Stock

11-48 If the preferred stock is noncumulative, any dividends not declared in previous years are lost permanently. Dividends on Preferred Stock

11-49 Kites, Inc. has the following stock outstanding: Common stock: $1 par, 100,000 shares Preferred stock: 3%, $100 par, cumulative, 5,000 shares Preferred stock: 6%, $50 par, noncumulative, 3,000 shares Dividends were not paid last year. In the current year, the board of directors declared dividends of $50,000. How much will each class of stock receive? Dividends on Preferred Stock

11-50 Dividends on Preferred Stock

11-51 Dividends on Preferred Stock

11-52 Dividends on Preferred Stock

11-53 Dividends on Preferred Stock

11-54 On June 1, 2003, a corporation’s board of directors declared a dividend for the 2,500 shares of its $100 par value, 8% preferred stock. The dividend will be paid on July 15. Which of the following will be included in the July 15 entry? a. Debit Retained Earnings $20,000. b. Debit Dividends Payable $20,000. c. Credit Dividends Payable $20,000. d. Credit Preferred Stock $20,000. Dividends on Preferred Stock

11-55 On June 1, 2000 a corporation’s board of directors declared a dividend for the 2,500 shares of its $100 par value, 8% preferred stock. The dividend will be paid on July 15. Which of the following will be included in the July 15 entry? a. Debit Retained Earnings $20,000. b. Debit Dividends Payable $20,000. c. Credit Dividends Payable $20,000. d. Credit Preferred Stock $20,000. $100 × 8% = $8 dividend per share $8 × 2,500 = $20,000 total dividend Dividends on Preferred Stock

11-56 Restrictions on Retained Earnings If I loan you $150,000, I will want you to restrict your retained earnings. Why would you want to do that?

11-57 Learning Objectives Discuss the impact of capital stock transactions on cash flows.

11-58 Focus on Cash Flows Outback

11-59 Accounting for Owners’ Equity for Sole Proprietorships and Partnerships Chapter Supplement A

11-60 Sole Proprietorships A sole proprietorship is owned by a one person. Two equity accounts CapitalDrawings

11-61 Sole Proprietorships On January 2, J. Doe started a retail store by investing $150,000 of his own money. The journal entry to record this business formation is:

11-62 Sole Proprietorships Each month, J. Doe withdraws $1,000 for personal living expenses. The January 30 journal entry to record the first withdrawal is:

11-63 Sole Proprietorships During the first year, J. Doe’s income totaled $18,000, and his withdrawals totaled $12,000. The equity section of J. Doe’s balance sheet at the end of the first year is: During the first year, J. Doe’s income totaled $18,000, and his withdrawals totaled $12,000. The equity section of J. Doe’s balance sheet at the end of the first year is:

11-64 Partnerships A partnership is owned by two or more individuals. Partnerships require clear agreements about authority, risks, and the sharing of profits and losses. A partnership is owned by two or more individuals. Partnerships require clear agreements about authority, risks, and the sharing of profits and losses. Separate capital and drawings accounts are maintained for each partner. Partnership income is divided among the partners according to the partnership agreement.

11-65 Partnerships Advantages Complete control by partners No income taxes on business Primary disadvantage Unlimited liability Ease of formation

11-66 On January 2, Able and Baker formed a partnership. Able contributed $60,000 cash. Jones contributed $40,000 cash. The partners agreed to divide partnership income in the ratio of their contributions (60:40). The journal entry to record this business formation is: Partnerships

11-67 The partners agreed that each month Able would withdraw $1,000 and Baker would withdraw $650. The January 30 journal entry to record the first withdrawal is: Partnerships

11-68 Partnerships During the first year, partnership income totaled $30,000. Withdrawals totaled $12,000 for Able and $7,800 for Baker. The equity section of the partnership balance sheet at the end of the first year is:

11-69 Accounting and Reporting for Three Types of Businesses

11-70 End of Chapter 11