The Statement of Stockholders’ Equity Module 5

Statement of Shareholders’ Equity Documents changes in balance sheet equity accounts from one accounting period to the next Provides an important link between the balance sheet and the income statement Company may report info in note or supplementary schedule rather than formal statement if desired….(many do!)

Statement of S/E In a nutshell, it simply explains how each account got from the balance at the beginning of the period to the balance at the end of the period and describes “events” that caused the balances to change Federal Express Statement of Changes in Stockholders' Equity

Retained Earnings Changes in R/E account are primarily result of net income/loss and dividends Balance can also be affected by prior period adjustments and some changes in accounting principles Changes in R/E are watched by analysts and the details on what caused the changes are documented in the Statement of Stockholders’ Equity

Ownership of a Corporation Owners of common stock generally receive the following rights: Voting (in person or by proxy). Distributions of profits (in the form of Dividends). Distributions of assets in a liquidation. Offers to purchase shares of a new stock issue (pro rata basis). 7

Authorized, Issued, and Outstanding Capital Stock Shares The maximum number of shares of capital stock that can be sold to the public is called the authorized number of shares. 10

Authorized, Issued, and Outstanding Capital Stock Authorized Shares Issued shares have been sold. Unissued shares have never been sold. 11

Authorized, Issued, and Outstanding Capital Stock Shares owned by stockholders. Outstanding Shares Unissued Shares Issued Shares 12

Authorized, Issued, and Outstanding Capital Stock Shares owned by stockholders. Outstanding Shares Unissued Shares Issued Shares Treasury Shares reacquired by the corporation. 13

Sale and Issuance of Capital Stock An initial public offering (IPO) is the very first time a corporation sells stock to the public. SEC's IPO Information 14

Common Stock Basic voting stock of the corporation Ranks after preferred stock for dividend and liquidation distribution. Dividend rates are determined by the board of directors based on the corporation’s profitability and other factors. 15

Par Value and No-par Value Stock Is a nominal value per share of capital stock specified in the charter. Has no relationship to market value. Serves as the basis for legal capital. Legal capital is the amount of capital, required by the state, that must remain invested in the business. It serves as a cushion for creditors. 16

Par Value and No-par Value Stock No-par value is capital stock that does not have an amount per share specified in the charter. When no-par stock is issued by a corporation, the amount of legal capital is defined by the state. Stated value is an amount per share that is specified by the corporation when it issues no-par stock. 17

Preferred Stock Has dividend and liquidation preference over common stock. Cumulative preferred stock has a preference for all past dividends over any paid to common shareholders. Generally does not have voting rights. Usually has a par or stated value. Usually has a fixed dividend rate that is stated as a percentage of the par value. 18

Special Features of Preferred Stock Convertible preferred stock may be exchanged for common stock. (It’s up to the stockholder to decide.) Callable preferred stock may be repurchased by the corporation at a predetermined price. (It’s the company’s choice.) 19

Accounting for Capital Stock Transactions Two primary sources of stockholders’ equity: Contributed capital Par or stated value of issued stock. Additional paid-in capital in excess of par or stated value. Retained earnings The cumulative net income earned by the corporation less the cumulative dividends declared by the corporation. 20

Accounting for the Issue of Common Stock When stock is issued, the equity account Common Stock is credited (increased) for the par or stated value of the stock. If the stock sold for more than par, the additional amount is credited (increased) to the equity account Paid in Capital in Excess of Par, Common Stock. 21

Treasury Stock A corporation’s own stock that had been issued but was subsequently reacquired and is still being held by that corporation. Why would a corporation reacquire its own stock? To reduce the shares outstanding. Because the market price is low. To increase earnings per share, if shares won’t be reissued soon. To use in employee stock option programs. 28

Treasury Stock is considered issued stock but not outstanding stock. has no voting or dividend rights. is a contra equity account. reduces total stockholders’ equity on the Balance Sheet. 29

Accounting for Cash Dividends Dividends must be declared by the board of directors before they can be paid. The corporation is not legally required to declare (and subsequently pay) dividends. Once a cash dividend is declared, a liability (Dividends Payable) is created. Cash dividends require sufficient cash and retained earnings, but NOT necessarily Net Income in the current year, to cover the dividend. 36

Dividend Dates Date of declaration Date of record Date of actual payment to shareholders 7 24 30 37

Some interesting side trips… Dividend calendar McGraw Hill Dividends are not always straightforward Dividend advice DRIPs

Dividends on Preferred Stock Current preferred dividends must be paid before paying any dividends to common stock. If a preferred dividend is not paid, the unpaid amount is either cumulative (a dividend in arrears) or noncumulative. Cumulative: Unpaid dividends must be paid before common dividends. Noncumulative: Unpaid dividends are lost. 38

Calculating Preferred and Common Dividends ABC Co. has 10 shares of $100 par, 6% cumulative preferred stock outstanding. Assume that NO dividends were paid in 19X1. At the end of 19X2, the Board of Directors declares a total of $200 worth of dividends for its preferred and common shareholders. How much will go to the preferred shareholders? 39

Preferred Shareholders get their dividends first: Cumulative means that the preferred shareholders get all the past dividends that they were not paid (called “dividends in arrears” which must be footnoted, but NOT reported as a liability on the balance sheet) before common stockholders can receive a dividend. 10 preferred shares x $100 par x .06 = $60/year They get a total of $120: $60 for 19X1 dividends in arrears and $60 for 19X2 current year dividend. Common shareholders get the remaining $80. ($80/30 shares outstanding=$2.67 per share.) [31 shares issued - 1 still in Treasury = 30 shares outstanding.] 40

Cash Dividends What’s needed to pay cash dividends? retained earnings cash (but, could borrow cash to pay dividend) no restrictions from outsiders Effects of cash dividends on financial statements decreases Assets (when they are actually paid) and Retained Earnings (dividends). NO EFFECT on Net Income. 42

Accounting for Stock Dividends Stock dividends are distributions to stockholders of additional shares of stock, NOT CASH! Why issue a stock dividend? Low on cash (but want to “reward” stockholders) To decrease market price of stock. Why? To increase number of stockholders (assuming some of the newly issued stock will be sold). 48

Accounting for Stock Dividends All stockholders receive the same percentage increase in the number of shares they own (pro rata basis). No change in total stockholders’ equity. No change in par values. Effect on financial statements? 49

Retained Earnings Appropriating (or Restricting) Retained Earnings Board of Directors can restrict (imposed by outsiders) or appropriate (company’s choice) portions of retained earnings. It is a way of communicating why more dividends are not being paid. Does NOT change TOTAL Ret. Earnings. An appropriation (or “restriction”) only separates the retained earnings into two categories, unappropriated and appropriated. (Must have Unappropriated or Unrestricted R.E. to declare dividends.) 57

Accounting for Stock Splits Distributions of 100% or more of stock to stockholders. Decreases par value per share of stock, but total par value stays the same. Increases number of outstanding shares. No change in total stockholders’ equity. 55

Stock Split: example XYZ Co. has 1000 shares outstanding. Each share has a $10 par value, but is selling on the NYSE for $80 per share. The Company declares a 4 for 1 stock split. Complete the following: Before After # shares outstanding Par value per share Total par value Total stock market value Market value per share 1,000 $10 $10,000 $80,000 $80 4,000 $2.50 $10,000 $80,000 $20 55

Stock Split: example continued XYZ Co. has 1000 shares outstanding. Each share has a $10 par value, but is selling on the NYSE for $80 per share. The Company declares a 4 for 1 stock split. Ms. Smith owned 100 shares before the split. Complete the following for Ms. Smith’s stock: Before After # shares owned…………... Total company shares…... % of stock owned………... Total market value of Ms. Smith’s stock……. 100 1,000 10% $8,000 400 4,000 10% $8,000 Remember, the stock price dropped from $80 to $20 per share. 55

Retained Earnings Represents the net income that has been earned less dividends that have been declared since the first day of operations for the company. Example (amounts assumed) Balance January 1, 20X1 $ 500,000 + Net income for 20X1 30,000 - Dividends for 20X1: Cash dividends (10,000) Stock dividends ( 5,000) Balance January 31, 20X1 $ 515,000 56

Retained Earnings What affects Retained Earnings? net income (through closing entries) cash dividends stock dividends prior period adjustments Accounting ERRORS made in previous years that are being corrected now. 57

The End