Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Spiceland | Thomas | Herrmann Financial Accounting Stockholders’ Equity Chapter 10

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Learning Objectives Identify the advantages and disadvantages of the corporate form of ownership Record the issuance of common stock Contrast preferred stock with common stock and bonds payable Account for treasury stock Describe retained earnings and record cash dividends

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Learning Objectives Explain the effect of stock dividends and stock splits Prepare and analyze the stockholders’ equity section of a balance sheet and the statement of stockholders’ equity Evaluate company performance using information on stockholders’ equity

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Stockholders’ Equity Primary Sections of Stockholders’ Equity Paid-in capital Retained Earnings Treasury Stock Amount stockholders have invested in the corporation Amount of earnings the corporation has retained Corporation’s own stock that it has reacquired

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Part A Invested Capital 10-5

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Learning Objective 1 Identify the advantages and disadvantages of the corporate form of ownership 10-6

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Corporations Articles of incorporation: corporate charter describing: Nature of business activities Shares of stock to be issued Initial board of directors The board of directors establish corporate policies and appoints officers who manage the corporation

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Illustration 10.2—Organization Chart 10-8

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Stages of Equity Financing Corporations first raise money from founders of the business, friends, and family To grow, companies seek investments from: Angel investors Venture capital firms Initial public offering (IPO)

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Illustration 10.3—Stages of Equity Financing 10-10

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Public or Private Allows public investment Many shareholders Stocks trade on stock exchanges or by over- the-counter (OTC) trading Regulated by the (SEC) Examples—Wal-Mart, Microsoft, Intel Does not allow investment by the general public Fewer stockholders Stocks not traded in the open market Not regulated by the (SEC) Examples—Cargill (agricultural commodities) Koch Industries (oil and gas), Chrysler (cars) PublicPrivate

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Illustration 10.4—Stockholder Rights 10-12

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Illustration 10.5—Advantages and Disadvantages of a Corporation 10-13

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Learning Objective 2 Record the issuance of common stock 10-14

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Common Stock Treasury stock: repurchased shares, included as part of shares issued, but excluded from shares outstanding

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Illustration 10.6—Authorized, Issued, and Outstanding Stock 10-16

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Par Value Legal capital per share of stock that’s assigned when the corporation is first established Has no relationship to the market value today

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Accounting for Common Stock Issues 10-18

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Learning Objective 3 Contrast preferred stock with common stock and bonds payable 10-19

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Preferred Stock Issued in addition to common stock to attract wider investment Preferred stockholders have: First rights to a specified amount of dividends Preference over common stockholders in the distribution of assets at the time of dissolution Most preferred stock does not have voting rights

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Illustration 10.7—Comparison of Financing Alternatives 10-21

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Features of Preferred Stock Flexibility allowed in its contractual provisions Types: Convertible: shares can be exchanged for common stock Redeemable: shares can be returned to the corporation at a fixed price Cumulative: shares receive priority for future dividends, if dividends are not paid in a given year Dividends in arrears - unpaid dividends

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Illustration 10.8—Allocate Dividends between Preferred and Common Stock 10-23

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Illustration 10.9—Stockholders’ Equity Section 10-24

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Learning Objective 4 Account for treasury stock 10-25

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Treasury Stock Corporation’s own stock that it has reacquired Companies buy back their own stock for various reasons: To boost underpriced stock To distribute surplus cash without paying dividends To boost earnings per share To satisfy employee stock ownership plans

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Purchase of Treasury Stock 10-27

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Illustration 10.11—Stockholders’ Equity before and after Purchase of Treasury Stock 10-28

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Reissuing Treasury Stock 10-29

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Illustration 10.12—Stockholders’ Equity before and after Sale of Treasury Stock 10-30

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Reissuing Treasury Stock 10-31

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Part B Earned Capital 10-32

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Learning Objective 5 Describe retained earnings and record cash dividends 10-33

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Retained Earnings Earnings retained in the corporation and not paid out as dividends Equals all net income, less all dividends Has a normal credit balance Accumulated deficit: a debit balance in retained earnings

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Dividends Distributions by a corporation to its stockholders Declaration date: date on which board of directors declare the cash dividend to be paid Record date: specific date on which the company will determine who will receive the dividend (registered owners of stock) Payment date: date of the actual cash distribution

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Recording Cash Dividends 10-36

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Learning Objective 6 Explain the effect of stock dividends and stock splits 10-37

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Stock Dividends and Stock Splits Stock dividends: additional shares of a company’s own stock given to stockholders as dividends Stock split: a large stock dividend that includes a reduction in the par or stated value per share You own 100 shares and assume a You will get 10% stock dividend10 additional shares 20% stock dividend20 additional shares 100% stock dividend100 additional shares Small stock dividend Large stock dividend or stock split (2-for-1)

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Stock Splits or Large Stock Dividends Stock split Reduces par value per share and increases shares outstanding No need to record transaction Large stock dividends Records an increase in common stock and decrease in retained earnings Recorded at par value

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Small Stock Dividends Recorded at market value Believed to have little impact on market price

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Part C Reporting Stockholders’ Equity 10-41

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Learning Objective 7 Prepare and analyze the stockholders’ equity section of a balance sheet and the statement of stockholders’ equity 10-42

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Illustration 10.17—Stockholders’ Equity Section 10-43

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Statement of Stockholders’ Equity Summarizes the changes in the balance in each stockholders’ equity account over a period of time

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Illustration 10.19—Statement of Stockholders’ Equity 10-45

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Learning Objective 8 Evaluate company performance using information on stockholders’ equity 10-46

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Return on Equity Measures the ability of company management to generate earnings from the resources that owners provide

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Return on the Market Value of Equity Analysts often relate earnings to the market value of equity Net income Market value of equity Return on the market value of equity =

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Earnings per Share Measures net income earned per share of common stock Useful in comparing earnings performance for the same company over time Not useful for comparing earnings performance of one company with another

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education Price-Earnings Ratio Indicates how the stock is trading relative to current earnings Commonly are in the range of 15 to 20 Growth stocks: stocks whose future earnings investors expect to be higher Value stocks: stocks that are priced low in relation to current earnings

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. End of Chapter