Chapter 11 Accounting for Equity

Business Entity Forms Sole Proprietorship Partnership Corporation C 5

* Proprietorships and partnerships that are set up as LLC’s provide limited liability. Characteristics of Businesses * * C 5

Owners of a corporation are called shareholders (or stockholders). When a corporation issues only one class of stock, we call it common stock (or capital stock). Corporation C 5

Privately Held Publicly Held Ownership can be Corporate Form of Organization Existence is separate from owners. An entity created by law. Has rights and privileges. C 1

Advantages Separate Legal Entity Limited Liability of Stockholders Transferable Ownership Rights Continuous Life Stockholders Are Not Corporate Agents Ease of Capital Accumulation Disadvantages Governmental Regulation Corporate Taxation Advantages Separate Legal Entity Limited Liability of Stockholders Transferable Ownership Rights Continuous Life Stockholders Are Not Corporate Agents Ease of Capital Accumulation Disadvantages Governmental Regulation Corporate Taxation Characteristics of Corporations C 1

Stockholders Board of Directors President, Vice-President, and Other Officers Employees of the Corporation Organizing and Managing a Corporation C 1

Ultimate control. Stockholders usually meet once a year. Organizing and Managing a Corporation Selected by a vote of the stockholders. Overall responsibility for managing the company. C 1

 Vote at stockholders’ meetings.  Sell stock.  Purchase additional shares of stock.  Receive dividends, if any.  Share equally in any assets remaining after creditors are paid in a liquidation.  Vote at stockholders’ meetings.  Sell stock.  Purchase additional shares of stock.  Receive dividends, if any.  Share equally in any assets remaining after creditors are paid in a liquidation. Rights of Stockholders C 1

Each unit of ownership is called a share of stock. A stock certificate serves as proof that a stockholder has purchased shares. Each unit of ownership is called a share of stock. A stock certificate serves as proof that a stockholder has purchased shares. Stock Certificates and Transfer When the stock is sold, the stockholder signs a transfer endorsement on the back of the stock certificate. C 1

Basics of Capital Stock Total amount of stock that a corporation’s charter authorizes it to sell. C 1

Basics of Capital Stock Total amount of stock that has been issued to stockholders. C 1

Par value is an arbitrary amount assigned to each share of stock when it is authorized. Market price is the amount that each share of stock will sell for in the market. Selling (Issuing) Stock  C 1

Par Value No-Par Value Stated Value Classes of Stock P1

Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share. Let’s record this transaction. Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share. Let’s record this transaction. Record: 1.The cash received. 2.The number of shares issued × the par value per share in the Common Stock account. 3.The remainder is assigned to Contributed Capital in Excess of Par. Record: 1.The cash received. 2.The number of shares issued × the par value per share in the Common Stock account. 3.The remainder is assigned to Contributed Capital in Excess of Par. Issuing Par Value Stock P1

Issuing Par Value Stock Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share. Let’s record this transaction. Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share. Let’s record this transaction. P1

Issuing Par Value Stock P1

Record: 1.The asset received at its market value. 2.The number of shares issued × the par value per share in the Common Stock account. 3.The remainder is assigned to Contributed Capital in Excess of Par. Record: 1.The asset received at its market value. 2.The number of shares issued × the par value per share in the Common Stock account. 3.The remainder is assigned to Contributed Capital in Excess of Par. Issuing Stock for Noncash Assets Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for land valued at $2,500,000. Let’s record this transaction. Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for land valued at $2,500,000. Let’s record this transaction. P1

Issuing Stock for Noncash Assets Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for land valued at $2,500,000. Let’s record this transaction. Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for land valued at $2,500,000. Let’s record this transaction. P1

A separate class of stock, typically having priority over common shares in... Dividend distributions. Distribution of assets in case of liquidation. A separate class of stock, typically having priority over common shares in... Dividend distributions. Distribution of assets in case of liquidation. Usually has a stated dividend rate. Normally has no voting rights. Preferred Stock C 3

Vs.NoncumulativeCumulative Dividends in arrears must be paid before dividends may be paid on common stock. Undeclared dividends from current and prior years do not have to be paid in future years. Cumulative or Noncumulative Dividend Most preferred stock is cumulative. P4

Vs.NonparticipatingParticipating Dividends may exceed a stated amount once common stockholders receive a dividend equal to the preferred stated rate. Dividends are limited to a maximum amount each year. The maximum is usually the stated dividend rate. Participating or Nonparticipating Dividend Most preferred stock is nonparticipating. P4

Reasons for Issuing Preferred Stock To raise capital without sacrificing control. To boost the return earned by common stockholders through financial leverage. To appeal to investors who may believe the common stock is too risky or that the expected return on common stock is too low. To raise capital without sacrificing control. To boost the return earned by common stockholders through financial leverage. To appeal to investors who may believe the common stock is too risky or that the expected return on common stock is too low. P4

To pay a cash dividend the corporation must have: 1.A sufficient balance in retained earnings and 2.The cash necessary to pay the dividend. Cash Dividends P2

Regular cash dividends provide a return to investors and almost always affect the stock’s market value. Dividends Stockholders June 30 Cash Dividends Corporation P2

Three important dates Date of Declaration Record liability for dividend. Dividends Date of Record No entry required. Date of Payment Record payment of cash to stockholders. Entries for Cash Dividends P2

Date of Declaration Record liability for dividend. Dividends On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. The dividend will be paid on March 19 to stockholders of record on February 19. Entries for Cash Dividends P2

Date of Record No entry required. Entries for Cash Dividends On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. The dividend will be paid on March 19 to stockholders of record on February 19. No entry required on February 19. P2

Date of Payment Record payment of cash to stockholders. Entries for Cash Dividends On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. The dividend will be paid on March 19 to stockholders of record on February 19. C 1

Created when a company incurs cumulative losses or pays dividends greater than total profits earned in other years. Deficits and Cash Dividends P2

The corporation distributes additional shares of its own stock to its stockholders without receiving any payment in return. Stock Dividends Why a stock dividend? Can be used to keep the market price on the stock affordable. Can provide evidence of management’s confidence that the company is doing well. Why a stock dividend? Can be used to keep the market price on the stock affordable. Can provide evidence of management’s confidence that the company is doing well. HotAir, Inc. Common Stock 100 shares $1 par P3

Here is the stockholders’ equity section of Quest’s balance sheet prior to the declaration of a small stock dividend. Recording a Small Stock Dividend P3

On December 31, 2008, Quest declared a 2% stock dividend, when the stock was selling for $10 per share. The stock will be distributed to stockholders on January 20, Let’s make the December 31 entry. Recording a Small Stock Dividend 100,000 × 2% = 2,000 × $10 = $20,000 2,000 × $1 par = $2,000 2,000 × $1 par = $2, ,000 × 2% = 2,000 × $10 = $20,000 2,000 × $1 par = $2,000 2,000 × $1 par = $2,000 P3

A distribution of additional shares of stock to stockholders according to their percent ownership. Common Stock $10 par value 100 shares Old Shares New Shares Common Stock $5 par value 200 shares Stock Splits P3

Thomas, Inc. has the following stockholders’ equity section just prior to a 2-for-1 stock split. Stock Splits P3

After the 2-for-1 split the stockholders’ equity section of the balance sheet looks like this... No accounting entry is made. No accounting entry is made. Stock Splits P3

Corporations acquire shares of their own stock. Why would a company do that? Why would a company do that? Use the shares to acquire control of another corporation. Use the shares to acquire control of another corporation. To avoid a hostile takeover. To avoid a hostile takeover. Use the shares for employee stock options. Use the shares for employee stock options. To maintain a strong market for its stock or show management confidence in the current price. To maintain a strong market for its stock or show management confidence in the current price. Use the shares to acquire control of another corporation. Use the shares to acquire control of another corporation. To avoid a hostile takeover. To avoid a hostile takeover. Use the shares for employee stock options. Use the shares for employee stock options. To maintain a strong market for its stock or show management confidence in the current price. To maintain a strong market for its stock or show management confidence in the current price. Treasury Stock P5

Treasury Stock P5

On May 8, Whitt, Inc. purchased 2,000 of its own shares of stock in the open market for $8,000. Purchasing Treasury Stock Treasury stock is shown as a reduction in total stockholders’ equity on the balance sheet. Treasury stock is shown as a reduction in total stockholders’ equity on the balance sheet. P5

On June 30, Whitt sold 100 shares of its treasury stock for $4 per share. Selling Treasury Stock at Cost $8,000 ÷ 2,000 shares = $4 cost per treasury share P5

On July 19, Whitt, Inc. sold an additional 500 shares of its treasury stock for $8 per share. Selling Treasury Stock Above Cost P5

On August 27, Whitt sold an additional 400 shares of its treasury stock for $1.50 per share. Selling Treasury Stock Below Cost P5

Earnings per share is one of the most widely cited items of accounting information. Earnings Per Share Basic earnings per share = Net income - Preferred dividends Weighted-average common shares outstanding A 1

The right to purchase common stock at a fixed price over a specified period of time. As the stock’s price rises above the fixed option price, the value of the option increases. Option purchase price $30 per share. Stock Options Market price of stock $75 per share. A 1

Options are given to key employees to motivate them to: focus on company performance, take a long-run perspective, and remain with the company. Options are given to key employees to motivate them to: focus on company performance, take a long-run perspective, and remain with the company. Stock Options A 1