McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Chapter Eleven: Stockholders’ Equity: Paid-in Capital

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Existence is separate from owners. An entity created by law. Has rights and privileges. Privately, or Closely, Held Publicly Held Ownership can be Corporations

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Limited personal liability for stockholders. Transferability of ownership. Professional management. Continuity of existence. Advantages of Incorporation

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Heavy taxation. Greater regulation. Cost of formation. Separation of ownership and management. Disadvantages of Incorporation

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Publicly Owned Corporations Face Different Rules By LAW, publicly owned corporations must: By LAW, publicly owned corporations must: Prepare financial statements in accordance with GAAP. Prepare financial statements in accordance with GAAP. Have their financial statement audited by an independent CPA. Have their financial statement audited by an independent CPA. Comply with federal securities laws. Comply with federal securities laws. Submit financial information for SEC review. Submit financial information for SEC review. By LAW, publicly owned corporations must: By LAW, publicly owned corporations must: Prepare financial statements in accordance with GAAP. Prepare financial statements in accordance with GAAP. Have their financial statement audited by an independent CPA. Have their financial statement audited by an independent CPA. Comply with federal securities laws. Comply with federal securities laws. Submit financial information for SEC review. Submit financial information for SEC review.

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved The costs associated with incorporation are usually expensed immediately, but amortized over 5 years for tax purposes. Formation of a Corporation Each corporation is formed according to the laws of the state where it is located. The application for corporate status is called the Articles of Incorporation.

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Stockholders Rights Voting (in person or by proxy). Proportionate distribution of dividends. Proportionate distribution of assets in a liquidation. Rights of Stockholders

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Ultimate control Stockholders usually meet once a year. Rights of Stockholders

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Ultimate control Stockholders usually meet once a year. Stockholder ledgers are often maintained by a stock transfer agent or stock registrar. Rights of Stockholders

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 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. Rights of Stockholders

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved When the stock is sold, the stockholder signs a transfer endorsement on the back of the stock certificate. Rights of Stockholders

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Overall responsibility for managing the company. Selected by a vote of the stockholders Functions of the Board of Directors

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Chief Accountant Contractual and legal representation Custodian of funds Functions of the Corporate Officers

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Stockholders’ Equity of a Corporation

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved The maximum number of shares of capital stock that can be sold to the public. Authorized Shares Authorized Shares Authorization and Issuance of Capital Stock

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Issued shares are authorized shares of stock that have been sold. Unissued shares are authorized shares of stock that never have been sold. Usually shares are sold through an underwriter. Authorized Shares Authorized Shares Authorization and Issuance of Capital Stock

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved UnissuedShares Treasury Shares Outstanding Shares Treasury shares are issued shares that have been reacquired by the corporation. Issued Shares Issued Shares Outstanding shares are issued shares that are owned by stockholders. Authorized Shares Authorized Shares Authorization and Issuance of Capital Stock

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 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. Stockholders’ Equity

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Common stock can be issued in three forms: No-Par Common Stock Par Value Common Stock Stated Value Common Stock All proceeds credited to Common Stock Treated like par value common stock Stockholders’ Equity Let’s examine this form of stock.

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Matrix, Inc. issues 10,000 shares of its $2 par value stock for $25 per share on September 1, Record: The cash received. The number of shares issued × the par value per share in the Common Stock account. The remainder is assigned to Contributed Capital in Excess of Par. Record: The cash received. The number of shares issued × the par value per share in the Common Stock account. The remainder is assigned to Contributed Capital in Excess of Par. Issuance of Par Value Stock

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Issuance of Par Value Stock Matrix, Inc. issues 10,000 shares of its $2 par value stock for $25 per share on September 1, ,000 × $2 = $20,000

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Issuance of Par Value Stock

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved A separate class of stock, typically having priority over common shares in...  Dividend distributions (rate is usually stated).  Distribution of assets in case of liquidation. A separate class of stock, typically having priority over common shares in...  Dividend distributions (rate is usually stated).  Distribution of assets in case of liquidation. Cumulative dividend rights. Normally has no voting rights. Usually callable by the company. Other Features Include: Preferred Stock

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved 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 Preferred Stock

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Example: Consider the following partial Statement of Stockholders’ Equity. During 2006, the directors declare cash dividends of $5,000. In 2007, the directors declare cash dividends of $42,000. Stock Preferred as to Dividends

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Stock Preferred as to Dividends

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved I just converted 100 shares of preferred stock into 1,000 shares of common stock and ended up with a higher dividend yield! MY Gee, I can’t do that with MY preferred stock! Some preferred stock is convertible into shares of common stock. Other Features of Preferred Stock

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Preferred Stock

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Accounting by the issuer. Accounting by the investor. Common stock is carried at original issue price. Investments in marketable securities are carried at market value. Market Value

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Factors affecting market price of preferred stock: Factors affecting market price of preferred stock: o Dividend rate o Risk o Level of interest rates Factors affecting market price of preferred stock: Factors affecting market price of preferred stock: o Dividend rate o Risk o Level of interest rates The return based on the market value is called the “dividend yield.” Market Price of Preferred Stock

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Factors affecting market price of common stock: Investors’ expectations of future profitability. Risk that this level of profitability will not be achieved. Factors affecting market price of common stock: Investors’ expectations of future profitability. Risk that this level of profitability will not be achieved. Changes in market value have no impact on the books of the issuer. Market Price of Common Stock

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Book Value per Share of Common Stock Total Stockholders’ Equity Number of Common Shares Outstanding Preferred stock and preferred dividends in arrears are deducted from total stockholders’ equity. Book Value Market Value =

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Ice Cream Parlor Banana Splits On Sale Now Stock Splits Companies use stock splits to reduce market price. Outstanding shares increase, but par value is decreased proportionately. Companies use stock splits to reduce market price. Outstanding shares increase, but par value is decreased proportionately.

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Assume a corporation has 5,000 shares of $1 par value common stock outstanding before a 2–for–1 stock split. Increase Decrease No Change Stock Split

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved No voting or dividend rights Contra equity account When stock is reacquired, the corporation records the treasury stock at cost. Treasury shares are issued shares that have been reacquired by the corporation. Treasury Stock

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved On May 1, 2006, East, Inc. reacquires 3,000 shares of its common stock at $55 per share. Prepare the journal entry for May 1. Treasury Stock - Example

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved On December 3, 2006, East Corp. reissued 1,000 shares of the stock at $75 per share. Prepare the journal entry for December 3. Treasury Stock - Example 1,000 shares × $55 cost = $55,000 1,000 shares × $75 = $75,000

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved Stockholders’ Equity - Presentation

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved End of Chapter Eleven