CHAPTER 15 Stockholders’ Equity: Contributed Capital ……..…………………………………………………………... Proprietorship Public Partnership Corporation Private Nonstock Stock Closed Listed OTC

THE CORPORATE FORM Incorporated in a single state Rights & privileges share profits & losses vote for directors share liquidation assets preemptive right Common stock: residual claim Preferred stock: often a prior, but limited, claim to earnings Limited liability Dividends from retained earnings approved by the board according to preference

CORPORATE CAPITAL  capital stock (common or preferred)  additional paid-in capital  retained earnings Par Value Stock  par value is generally low: no contingent liability for discount; tax benefits

No-Par Stock  issued without a premium or discount  some states require no-par stock to have a minimum stated value

Lump Sum Sales  two or more classes of stock issued together Proportional Method  lump sum is allocated based on relative market value of each class Incremental Method  book value = market value for the class with a known market value  remainder of lump sum is allocated to the class with no known market value

Example Evans Corp. issues 10,000 bonds ($500 par, 12%) and 100,000 shares of common stock ($5 par) for $8,800,000. Incremental Method Assume the market rate on the bonds is 12% and the market value of the stock is unknown.

Proportional Method Assume the market rate on the bonds is 12% and the market value of the stock is $40. Mkt ValueBook Value Bonds$5,000,000$8,800,000 x 5/9$4,888,889 Stock4,000,000$8,800,000 x 4/93,911,111

Stock Issued for Noncash Consideration  use the fair market value of the stock or the fair market value of the consideration, which either is clearer  independent appraisal, if necessary  do not use par value as a basis  do not use book value of treasury stock as a basis Costs of Issuing Stock  reduction on Additional Paid-in Capital

Reacquisition of Stock  a form of distribution to stockholders  tax advantages  improves some ratios (eg. EPS)  to block a takeover Example Konar Corp issues 50,000 shares of $3 par common stock for $750,000.

The firm purchases 10,000 shares of common stock ($3 par value) for $30/share. The stock was originally issued for $15 per share. Cost Method Resold 2,000 treasury shares at $32/share.

Retired 8,000 treasury shares.

PREFERRED STOCK  cumulative preferred  dividends in arrears must be paid before any distribution to common stockholders  participating preferred  or partially participating  convertible preferred  to common at stockholders’ option  callable preferred  redeemable at option of the firm

DIVIDEND POLICY Legal Issues  solvency requirement  some states limit to retained or current earnings  some states limit to fair value of net assets Legal Issues  solvency requirement  some states limit to retained or current earnings  some states limit to fair value of net assets Economic Issues  liquidity  future cash needs Economic Issues  liquidity  future cash needs Communication Issues  smooth dividend stream (Kellogg Co.)  disclosure of dividend policy Communication Issues  smooth dividend stream (Kellogg Co.)  disclosure of dividend policy

Date of Declaration Cash Dividends Date of Record Date of Distribution

Property Dividends  most common form: securities  record at fair value of assets transferred  recognize gain or loss on assets at time dividend is declared

Date of Declaration Liquidating Dividends  dividends not based on retained earnings  a return of stockholders’ investment; reduction in paid-in capital  must be clearly explained to stockholders Date of Payment

Date of Declaration Stock Dividends  to capitalize part of earnings  proportionate interests remained unchanged  record at fair market value is less than 20-25% Date of Distribution

Date of Declaration Large Stock Dividends  more than 20-25%  usually reduces the market value of the stock  record at par value of stock issued Stock Split  no entry recorded  no. of shares  ; par value per share 

AssetsLiabS/E Pd-in Capital R/E Net Income Exercise 15-11

AssetsLiabS/E Pd-in Capital R/E Net Income Exercise (cont.)

AssetsLiabS/E Pd-in Capital R/E Net Income Extras Recorded increase in value of investment. Declared a property dividend. Distributed the property dividend.

AssetsLiabS/E Pd-in Capital R/E Net Income Purchase of treasury stock Retirement of treasury stock Sale of common stock above par

Dividend Preferences Exercise % preferred, $10 par, 20,000 shares out$ 200,000 Common, $100 par, 30,000 shares out3,000,000 Retained earnings630,000 PreferCommonBalance $366,000 One year arrears$ 14,000352,000 Cumulative, participating

PreferCommonBalance $366,000 PreferCommonBalance $366,000 Noncumulative, nonparticipating Noncumulative, participating beyond 10% to common

RETAINED EARNINGS  income kept for use in the business  to finance expansion  increased by net income; decreased by dividends  prior period adjustments made directly to retained earnings  legal or contractual restrictions placed on retained earnings should be disclosed in the footnotes

Comm Stock Add Pd-in R/E Accum Other Comp I Total SE Balance, $ 150$1,050$3,000$ 80$4,280Net Income 700 Unrealized Gain 30 Cash Dividends (130) Repurch & retirement of common stock (10)(70)(40)(120) Balance, $ 140$ 980$3,530$ 110$4,760 Statement of Stockholders’ Equity

Rate of Return on Common Stock Equity Net Income - Preferred Dividends Average Common SE = Payout Ratio Cash Dividends to Common Net Income - Preferred Dividends = Analysis  a profitability measure  payout ratios have been declining for several yrs Income available to common stockholders SE less par value of preferred stock

Price Earnings Ratio Market Price of Stock Earnings per Share = Book Value per Share Common Stockholders’ Equity Outstanding Shares =  ratio commonly used by analysts  P/E ratios were very high for many firms in the late 1990s Stockholders’ equity - par value of preferred stock - dividends in arrears - preferred dividends for current year