Chapter 13 Stockholders’ Equity

Learning Objectives 1.Identify the characteristics of a corporation 2.Journalize the issuance of stock 3.Account for the purchase and sale of treasury stock 4.Account for cash dividends, stock dividends, and stock splits 13-2 © Pearson Education, Inc.

Learning Objectives 5.Explain how equity is reported for a corporation 6.Use earnings per share, rate of return on common stock, and the price/earnings ratio to evaluate business performance 13-3 © Pearson Education, Inc.

Learning Objective 1 Identify the characteristics of a corporation 13-4 © Pearson Education, Inc.

What Is a Corporation? A corporation is a business organized under state law that is a separate legal entity. Corporations dominate business activity in the United States. Most well-known companies are corporations © Pearson Education, Inc.

Characteristics of Corporations Unique characteristics of corporations: – Separate legal entity – Number of owners – No personal liability of the owner(s) – Lack of mutual agency – Indefinite life – Taxation – Capital accumulation 13-6 © Pearson Education, Inc.

Characteristics of Corporations 13-7 © Pearson Education, Inc.

Stockholders’ Equity Basics The maximum number of shares of stock a corporation may issue is called authorized stock. Issued stock has been issued by the corporation. Stock held by the stockholders is called outstanding stock. Stockholders are issued stock certificates. Capital stock represents a stockholder’s ownership © Pearson Education, Inc.

Stockholders’ Equity Basics 13-9 © Pearson Education, Inc.

Stockholders’ Equity Basics © Pearson Education, Inc.

Stockholders’ Rights A stockholder has four basic rights: 1.Vote: Each share of basic ownership in the corporation carriers one vote. 2.Dividends: Stockholders receive a proportionate part of any dividend declared and paid. 3.Liquidation: Stockholders receive their proportionate share of any assets remaining after liquidation. 4.Preemptive right: Stockholders have a right to maintain their proportional ownership. © Pearson Education, Inc.

Capital Stock Corporations issue different classes of stock: – Common stock – Preferred stock Stock may carry a par value or may be no-par stock. Stated value stock is no-par stock that has been assigned an amount similar to par value © Pearson Education, Inc.

Stockholders’ Equity A corporation’s equity is called stockholders’ equity. The two basic sources of stockholders’ equity are: – Paid-in capital – Retained earnings © Pearson Education, Inc.

Learning Objective 2 Journalize the issuance of stock © Pearson Education, Inc.

How Is the Issuance of Stock Accounted For? Companies raise capital by issuing stock. A company can sell its stock directly to stockholders, or it can use the services of an underwriter. Stocks of public companies are bought and sold on a stock exchange, such as the New York Stock Exchange (NYSE) or NASDAQ Stock Market. The issue price is the amount a corporation receives from issuing stock © Pearson Education, Inc.

Issuing Common Stock at Par Value Smart Touch Learning’s common stock carries a par value of $1 per share, and the charter authorizes 20,000,000 shares of common stock. The stock issuance of 15,000 shares of stock at par value is recorded as: © Pearson Education, Inc.

Issuing Common Stock at a Premium Smart Touch Learning issues an additional 3,000 shares for $5 per share. The $4 difference between the issue price ($5) and the par value ($1) is a premium, recorded in Paid-in Capital in Excess of Par © Pearson Education, Inc.

Issuing Common Stock at a Premium © Pearson Education, Inc.

Issuing No-Par Common Stock Smart Touch Learning’s common stock is no-par. Assume the company issues 15,000 shares for $1 and 3,000 shares for $ © Pearson Education, Inc.

Issuing No-Par Common Stock © Pearson Education, Inc.

Issuing Stated Value Common Stock Smart Touch Learning issues 3,000 shares of $1 stated value stock for $5 per share. Accounting for stated value stock is similar to accounting for par value stock © Pearson Education, Inc.

Issuing Common Stock for Assets Other Than Cash Smart Touch Learning receives furniture with a market value of $18,000 in exchange for 5,000 shares of its $1 par common stock. It is recorded at the market value of the stock issued or of the asset received, whichever is more determinable © Pearson Education, Inc.

Issuing Preferred Stock Smart Touch Learning issues 1,000 shares of its $50 par, 6% preferred stock on January 3, 2017, at $55 per share © Pearson Education, Inc.

Issuing Preferred Stock © Pearson Education, Inc.

Learning Objective 3 Account for the purchase and sale of treasury stock © Pearson Education, Inc.

How Is Treasury Stock Accounted For? Treasury stock is a company’s stock that it has previously issued and later reacquired. Companies purchase treasury stock to: – Increase net assets by buying low and selling high – Support the company’s stock price – Avoid a takeover – Reward valued employees with stock © Pearson Education, Inc.

Treasury Stock Basics The basics of accounting for treasury stock: – The Treasury Stock account has a normal debit balance. Treasury Stock is a contra equity account. – Treasury stock is recorded at cost, without reference to par value. – The Treasury Stock account is reported beneath Retained Earnings on the balance sheet as a reduction to equity © Pearson Education, Inc.

Purchase of Treasury Stock On March 31, Smart Touch Learning purchased 1,000 shares of previously issued common stock, paying $5 per share © Pearson Education, Inc.

Sale of Treasury Stock Smart Touch Learning sells 100 of the treasury shares on April 1 for $5 each © Pearson Education, Inc.

Sale Above Cost Smart Touch Learning resold 200 of its treasury shares for $6 per share on April 2. (Recall the cost was $5 per share.) © Pearson Education, Inc.

Sale Below Cost On April 3, Smart Touch Learning resold 200 treasury shares for $4.30 each © Pearson Education, Inc.

Sale Below Cost What happens if Smart Touch Learning resells an additional 200 treasury shares for $4.50 each on April 4? © Pearson Education, Inc.

Sale of Treasury Stock © Pearson Education, Inc.

Learning Objective 4 Account for cash dividends, stock dividends, and stock splits © Pearson Education, Inc.

How Are Dividends and Stock Splits Accounted For? A profitable corporation may make distributions to stockholders in the form of dividends. Dividends can be paid in the form of cash, stock, or other property. Legal capital refers to the portion of stockholders’ equity that cannot be used for dividends © Pearson Education, Inc.

Cash Dividends Three dividend dates are relevant: Declaration date The board of directors announces the intention to pay the dividend, and a liability is created. Date of record This is the date the corporation records the stockholders that will receive dividend checks. Payment date This is the date the dividend is paid to the stockholders. © Pearson Education, Inc.

Declaring and Paying Dividends – Common Stock On May 1, Smart Touch Learning declares a $0.05 per share cash dividend on 22,700 outstanding shares of common stock © Pearson Education, Inc.

Declaring and Paying Dividends – Common Stock On May 15, the date of record, no journal entry is recorded. On May 30, Smart Touch Learning pays the dividend to its shareholders © Pearson Education, Inc.

Declaring and Paying Dividends – Preferred Stock A preferred stock dividend in arrears is a dividend that has not been paid for the year. Preferred stock can be: – Cumulative preferred stock – Noncumulative preferred stock © Pearson Education, Inc.

Declaring and Paying Dividends – Preferred Stock Suppose Greg’s Games’ preferred stock is cumulative and in 2016 the business did not pay any cash dividends. Greg’s Games must first pay preferred dividends of $3,000 (1,000 shares × $50 per share × 6%) for 2016 and $3,000 for Assume on September 6, 2017, Greg’s Games declares a $50,000 total dividend © Pearson Education, Inc.

Declaring and Paying Dividends – Preferred Stock © Pearson Education, Inc.

Stock Dividends A stock dividend is a distribution of a corporation’s own stock to its shareholders. Stock dividends have the following characteristics: – They affect only stockholders’ equity accounts. – They have no effect on total stockholders’ equity. – They have no effect on assets or liabilities © Pearson Education, Inc.

Why Issue Stock Dividends? A company issues stock dividends in order to: – Continue dividends but conserve cash – Reduce the market price per share of its stock – Reward investors © Pearson Education, Inc.

Recording Stock Dividends There are three dates for a stock dividend: – Declaration date – Record date – Distribution date A small stock dividend is less than 20% to 25% of issued and outstanding stock. A large stock dividend is greater than 20% to 25% of issued and outstanding stock © Pearson Education, Inc.

Recording Stock Dividends Greg’s Games distributes a 5% common stock dividend on 2,000,000 shares issued and outstanding when the market value is $50 per share. Greg’s Games will issue 100,000 (2,000,000 × 0.05) shares to its stockholders © Pearson Education, Inc.

Recording Stock Dividends On February 25, Greg’s Games distributes the common stock and records the following: © Pearson Education, Inc.

Recording Stock Dividends © Pearson Education, Inc.

Stock Splits A stock split is fundamentally different from a stock dividend. A stock split increases the number of issued and outstanding shares of stock. A stock split decreases the par value and the market value per share, whereas stock dividends do not affect par value per share © Pearson Education, Inc.

Cash Dividends, Stock Dividends, and Stock Splits Compared © Pearson Education, Inc.

Learning Objective 5 Explain how equity is reported for a corporation © Pearson Education, Inc.

How Is Equity Reported for a Corporation? The statement of retained earnings reports how the company’s retained earnings balance changed from the beginning of the period to the end of the period. Companies can report a negative amount in retained earnings. This is called a deficit. © Pearson Education, Inc.

Statement of Retained Earnings © Pearson Education, Inc.

Appropriations of Retained Earnings Cash dividends and treasury stock purchases require a cash payment. Banks often require a company to maintain a minimum level of stockholders’ equity. Appropriations of retained earnings are retained earnings restrictions recorded by journal entries © Pearson Education, Inc.

Prior-Period Adjustments Occasionally a company may make an accounting error as a result of mathematical mistakes or other errors not discovered until the following period. Corrections to Retained Earnings for errors of an earlier period are called prior-period adjustments. © Pearson Education, Inc.

Prior-Period Adjustments © Pearson Education, Inc.

Statement of Stockholders’ Equity © Pearson Education, Inc.

Learning Objective 6 Use earnings per share, rate of return on common stock, and the price/earnings ratio to evaluate business performance © Pearson Education, Inc.

How Do We Use Stockholders’ Equity Ratios to Evaluate Business Performance? Investors are constantly comparing companies’ profits. Three important ratios used for comparison are: – Earnings per share (EPS) – Rate of return on common stock – Price/earnings ratio © Pearson Education, Inc.

Earnings per Share The final segment of a corporate income statement reports the company’s earnings per share (EPS). EPS is the most widely used of all business statistics. EPS reports the amount of net income (loss) for each share of the company’s outstanding common stock. © Pearson Education, Inc.

earnings per share Green Mountain Coffee Roasters, Inc., Fiscal 2013 Annual Report reports the following amounts: © Pearson Education, Inc. Green Mountain Coffee Roasters, Inc., earnings per share for 2013 is computed as follows:

Price/Earnings Ratio The price/earnings ratio is the ratio of the market price of a share of common stock to the company’s earnings per share. This ratio tells investors how much they should be willing to pay for $1 of a company’s earnings. © Pearson Education, Inc.

Rate of Return on Common Stock Rate of return on common stockholders’ equity, often shortened to return on equity, shows the relationship between net income to common stockholders and their average common equity invested in the company © Pearson Education, Inc.

13-63 © Pearson Education, Inc.