Module 9 Reporting and Analyzing Owner Financing

Stockholders’ Equity Total stockholders’ equity is divided into two components: Contributed capital - proceeds received by the issuing company from original stock issuances, net of the amounts paid to repurchase shares of the issuer’s stock from its investors Earned capital - Retained earnings and accumulated other comprehensive income (AOCI). In addition, many companies report an equity account called noncontrolling interest, which reflects the equity of minority shareholders. In addition, many companies report an equity account called noncontrolling interest, which reflects the equity of minority shareholders.

Common Shares Authorized—Number of shares that can be issued based on the corporate charter. Authorized—Number of shares that can be issued based on the corporate charter. Issued—Number of shares that have been issued in the past. Issued—Number of shares that have been issued in the past. Outstanding—Number of shares currently owned by stockholders. Outstanding—Number of shares currently owned by stockholders. Authorized >= Issued >= Outstanding Authorized >= Issued >= Outstanding Example: Example: Common Stock, $1 par, 100,000 shares authorized, 80,000 shares issued, and 75,000 shares outstanding. Common Stock, $1 par, 100,000 shares authorized, 80,000 shares issued, and 75,000 shares outstanding.

Equity Components Average issue price: (CS+APIC)/Shares issued=($386+$4,000)/385.9 = $11.37 Average treasury stock purchase price = $2,079 / 53.6 = $38.79 Shares outstanding = Shares issued – Shares in treasury = – 53.6 = Book value per share = $8,251 / = $24.83

Types of Stock There are two classes of stock: There are two classes of stock: 1. Preferred Stock 2. Common Stock Preferred stock preferences: Preferred stock preferences: 1. Dividend preference – preferred shareholders receive dividends on their shares before common shareholders do. 2. Liquidation preference –preferred shareholders receive payment in full before common shareholders in liquidation.

Preferred Stock Privileges 1. Conversion privileges – a conversion privilege allows preferred stockholders to convert their shares into common shares at a predetermined conversion ratio. 2. Participation feature – allows preferred shareholders to share ratably with common stockholders in dividends. 3. Issuance—issued often in the acquisition of another company, public utilities, and some banks.

Preferred and Common Dividends Assume that a company has 15,000 shares of $50 par value, 8% preferred stock outstanding and 50,000 shares of $5 par value common stock outstanding. Assume that a company has 15,000 shares of $50 par value, 8% preferred stock outstanding and 50,000 shares of $5 par value common stock outstanding. During its first three years in business, the company declares $20,000 dividends in the first year, $260,000 of dividends in the second year, and $60,000 of dividends in the third year. During its first three years in business, the company declares $20,000 dividends in the first year, $260,000 of dividends in the second year, and $60,000 of dividends in the third year. If the preferred stock is cumulative (most are), the total amount of dividends paid to each class of stock in each of the three years follows: If the preferred stock is cumulative (most are), the total amount of dividends paid to each class of stock in each of the three years follows:

Preferred and Common Dividends (cont’d)

Accounting for Stock Dividends and Splits Stock Split: No accounting entry. Reduce the par $ and increase the shares Example: A 2-for-1 split of 10,000, $10 par shares would result in 20,000 shares of $5 par stock.

Employee Stock Options Stock Option—right to purchase common stock at a specific price for a number of years. Stock Option—right to purchase common stock at a specific price for a number of years. Fair value of the option—must be recorded as an expense and additional capital. Fair value of the option—must be recorded as an expense and additional capital. Fair value is commonly estimated with Black & Scholes model of option value: an increasing function of current price, variation, drift upwards, time and decreasing function of dividends. Fair value is commonly estimated with Black & Scholes model of option value: an increasing function of current price, variation, drift upwards, time and decreasing function of dividends. Example: Profitable Company offers you options for 10,000 shares for 10 years at today’s price of $5 per share, expected to increase at a rate of 8% per year, but price varies by 30% in a given year. The value of this option would be about $21,500. Example: Profitable Company offers you options for 10,000 shares for 10 years at today’s price of $5 per share, expected to increase at a rate of 8% per year, but price varies by 30% in a given year. The value of this option would be about $21,500.

Restricted Stock Restricted Stock—Employee awarded right to receive shares, but shares not awarded until work is done. Restricted Stock—Employee awarded right to receive shares, but shares not awarded until work is done. First recorded as unearned compensation (a contra- equity) and additional capital. First recorded as unearned compensation (a contra- equity) and additional capital. As shares awarded for work done, then compensation expense and reduce the unearned compensation. As shares awarded for work done, then compensation expense and reduce the unearned compensation. Less incentive than options to take on risky projects. Less incentive than options to take on risky projects. Safe Co. awards you the right to receive 10,000 shares at a rate of 2,000 shares per year of work. Stock is currently selling for $5 per share. Safe Co. awards you the right to receive 10,000 shares at a rate of 2,000 shares per year of work. Stock is currently selling for $5 per share.

Noncontrolling Interest Noncontrolling interest represents the equity of noncontrolling (minority) shareholders who only have a claim on the net assets of one or more of the subsidiaries in the consolidated entity. Noncontrolling interest represents the equity of noncontrolling (minority) shareholders who only have a claim on the net assets of one or more of the subsidiaries in the consolidated entity. When a company acquires less than 100% of the subsidiary, it must include 100% of the subsidiary’s assets, liabilities, revenues and expenses in its consolidated balance sheet and income statement. When a company acquires less than 100% of the subsidiary, it must include 100% of the subsidiary’s assets, liabilities, revenues and expenses in its consolidated balance sheet and income statement. There are two groups of shareholders that have a claim on the net assets and earnings of the subsidiary company: There are two groups of shareholders that have a claim on the net assets and earnings of the subsidiary company: The parent company shareholders, and The parent company shareholders, and The noncontrolling shareholders (those shareholders who continue to own shares of the subsidiary company). The noncontrolling shareholders (those shareholders who continue to own shares of the subsidiary company).

Equity Carve Outs Corporate divestitures have become increasingly common. Corporate divestitures have become increasingly common. Sell-off: Sale of a business unit or subsidiary to another company. Sell-off: Sale of a business unit or subsidiary to another company. Spin-off: Distribute shares of subsidiary as a dividend to owners. Spin-off: Distribute shares of subsidiary as a dividend to owners. Split-off: Trade shares of subsidiary for shares of parent company. Split-off: Trade shares of subsidiary for shares of parent company.

Global Accounting Under IFRS, accounting for equity is similar to that under U.S. GAAP. Following are a few terminology differences: Under IFRS, accounting for equity is similar to that under U.S. GAAP. Following are a few terminology differences:

Global Accounting U.S. GAAP has a more narrow definition of liabilities than IFRS. Therefore, more items are classified as liabilities under IFRS. U.S. GAAP has a more narrow definition of liabilities than IFRS. Therefore, more items are classified as liabilities under IFRS. For example, some redeemable preferred shares are deemed liabilities under IFRS and equity under GAAP. For example, some redeemable preferred shares are deemed liabilities under IFRS and equity under GAAP. Treasury stock transactions are sometimes difficult to identify under IFRS because companies are not required to report a separate line item for treasury shares on the balance sheet. Instead treasury share transactions reduce share capital and share premium. Treasury stock transactions are sometimes difficult to identify under IFRS because companies are not required to report a separate line item for treasury shares on the balance sheet. Instead treasury share transactions reduce share capital and share premium.