Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Sources of Capital: Owners’ Equity © The McGraw-Hill Companies, Inc., Part One: Financial Accounting

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Forms of Business Organizations Slide 9-1 Owned by an individual No incorporation fees No special reports Profits taxed at proprietor’s personal tax rate Personally responsible for the entity’s debts Borrow money as an individual Owned by an individual No incorporation fees No special reports Profits taxed at proprietor’s personal tax rate Personally responsible for the entity’s debts Borrow money as an individual Sole Proprietorship

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Forms of Business Organizations Slide 9-2 Owned by two or more persons Each partner is personally liable for all debts incurred by firm Each partner is responsible for business actions of other partners Taxed as individuals Owned by two or more persons Each partner is personally liable for all debts incurred by firm Each partner is responsible for business actions of other partners Taxed as individuals Partnership

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Forms of Business Organizations Slide 9-3 Legal entity with essentially perpetual existence Granted a charter to operate Taxed as an entity Limited liability to owners Ownership of an individual is easily added or liquidated Legal entity with essentially perpetual existence Granted a charter to operate Taxed as an entity Limited liability to owners Ownership of an individual is easily added or liquidated Corporation

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999  There may be significant legal and other fees involved in formation.  The corporation’s activities are limited to those specifically granted in its charter.  It is subject to numerous regulations and requirements.  It must secure permission from each state in which it wishes to operate.  Its income is subject to double taxation.  There may be significant legal and other fees involved in formation.  The corporation’s activities are limited to those specifically granted in its charter.  It is subject to numerous regulations and requirements.  It must secure permission from each state in which it wishes to operate.  Its income is subject to double taxation. Disadvantages of the Corporation Form Slide 9-4

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Salary$60,000$20,000$40,000 Interest on capital8,0002,4005,600 Remainder12,000 6,000 6,000 Total$80,000$28,400$51,600 Partnership Equity Slide 9-5 The partnership agreement of Jackson and Curtin provided that Jackson would receive a salary of $20,000 and Curtin a salary of $40,000; that each would receive 8 percent interest on their invested capital; and they they would share any remainder equally. The partnership’s net income for the year is $80,000. Total Jackson Curtin

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Salary$60,000$20,000$40,000 Interest on capital8,0002,4005,600 Remainder12,000 6,000 6,000 Total$80,000$28,400$51,600 Partnership Equity Slide 9-6 If the partnership agreement is silent concerning the remainder, then it is divided equally. Total Jackson Curtin

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Recording a Common Stock Issue Slide 9-7 Kuick Corporation is authorized to issue 200,000 shares of $1 par value common stock. Of these, 100,000 shares were issued at $7 per share. Cash700,000 Common Stock at Par100,000 Additional Paid-In Capital600, ,000 x $1

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Cash Dividend Slide 9-8 Kuick Corporation declares a $6,000 dividend on December 15 to be paid on January 15 to holders of record as of January 1. December 15 Retained Earnings6,000 Dividends Payable6,000 January 1 (no entry) January 15 Dividends Payable6,000 Cash6,000

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Stock Dividend Slide 9-9 Kuick Corporation declares and issues a 5 percent stock dividend to the holders of its 100,000 outstanding shares (par value of $1) when the market price of a share is $ Retained Earnings52,500 Common Stock at Par5,000 Additional Paid-In Capital47,500 5,000 x $ ,000 x $ ,000 x $1 5,000 x $1

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Common stock, $25 per share$ 77.6 $ 77.5 Capital in excess of par Retained earnings Treasury stock, at cost(1,653.1)(1,105.0) Total stockholders’ equity$1,905.9 $2,075.6 Balance Sheet Presentation Slide 9-10 PRESTON COMPANY AND SUBSIDIARIES Consolidated Balance Sheet At December 31 (millions)

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Basic Earnings Per Share Slide 9-11 Basic earnings per share is a measurement of the corporation’s per share performance over a period of time. Earnings per share = Net income Number of shares of common stock outstanding Earnings per share = $7,000,000 1,000,000 shares = $7 Assume Nugent Corporation had net income of $7 million and 1 million shares of common stock outstanding.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 = $6.20 Now, assume that Nugent Corporation also has 100,000 shares of $8 convertible preferred stock. Basic Earnings Per Share Slide 9-12 Earnings per share = Net income - Preferred dividends Number of shares of common stock outstanding Earnings per share = $7,000,000 - $800,000 1,000,000 shares

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 = $5.83 For diluted earnings per share, we assume that the 100,000 convertible preferred shares are exchanged for 200,000 shares of common stock. Earnings Per Share Slide 9-13 Earnings per share = Net income - Preferred dividends Number of shares of common stock outstanding Earnings per share = $7,000,000 1,200,000 shares

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 = $5.83 For diluted earnings per share, we assume that the 100,000 convertible preferred shares are exchanged for 200,000 shares of common stock. Slide 9-14 Earnings per share = Net income - Preferred dividends Number of shares of common stock outstanding Earnings per share = $7,000,000 1,200,000 shares Note that all the preferred stock is assumed converted, so there would be no dividends. Note that all the preferred stock is assumed converted, so there would be no dividends. 1,000,000 shares of common stock plus the 200,000 shares assumed from converting preferred stock 1,000,000 shares of common stock plus the 200,000 shares assumed from converting preferred stock Earnings Per Share

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., ,000,000 x 12/12 =1,000, ,000 x 6/12 = 250,000 Denominator amount1,250,000 Slide 9-15 Weighted-Average Number of Shares Optel Corporation had 1 million shares of common stock outstanding on January 1. On July 1 it issued an additional 500,000 shares. How many weighted-average shares would be used for calculating earnings per share?

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Slide 9-16 Zero-Coupon Bonds Bonds with a total par of $100,000 and carrying zero interest are issued when the current yield is 14 percent. How much should the investor pay for each $1,000 bond? $1,000 x.519 = $519 per $1,000 bond No cash is paid by the borrower until these bonds mature.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Slide 9-17 Debt With Warrants Some corporations issue warrants in conjunction with the issuance of bonds, putting an exercise price on the warrants of about 15 to 20 percent above the current market price of the common stock. If detachable, the warrants can be removed from the debt and used to purchase the issuer’s stock or sold to a third party.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Slide 9-18 Debt With Warrants If nondetachable, the debt is accounted for as if it were a convertible debt security--no recognition is given to the equity character of the debt. Some corporations issue warrants in conjunction with the issuance of bonds, putting an exercise price on the warrants of about 15 to 20 percent above the current market price of the common stock.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Slide 9-19 Redeemable Preferred Stock Redeemable preferred stock not only pays dividends, it may also be redeemed by the investor on or after a certain date. The SEC requires that redeemable preferred stock be listed as a separate item on the balance sheet at it’s redemption price. This item must be listed between the liability and owners’ equity section and not included in the total of either liabilities or owner’s equity.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Slide 9-20 Redeemable Preferred Stock Redeemable preferred stock$ 8,000,000 Stockholders’ equity: Common $1 par20,000,000 Additional paid-in capital 75,000,000 Total paid-in capital95,000,000 Retained earnings 60,000,000 Total stockholders’ equity$155,000,000 Redeemable preferred stock$ 8,000,000 Stockholders’ equity: Common $1 par20,000,000 Additional paid-in capital 75,000,000 Total paid-in capital95,000,000 Retained earnings 60,000,000 Total stockholders’ equity$155,000,000 The $8 million for redeemable preferred stock is not included. The $8 million for redeemable preferred stock is not included.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Chapter 9 The End