11 7/e PowerPoint Author: Catherine Lumbattis COPYRIGHT © 2011 South-Western/Cengage Learning Stockholders’ Equity Statements and the Annual Report

Disadvantages Advantages Advantages of Stock vs. Debt Financing  Flexibility  Exchanges facilitates trading  Return on investment LO1

Disadvantages of Stock vs. Debt Financing  Control  Tax consequences  Impact on ratios Disadvantages Advantages

Expanded Accounting Equation Assets = Liabilities + Owners’ Equity Assets = Liabilities + Stockholders’ Equity Contributed Capital Retained Earnings

Retained Earnings Connects the Income Statement and Balance Sheet Statement of Retained Earnings Retained Earnings, Beginning Balance$ xxx Add: Net Income inc Deduct: Dividends xxx Retained Earnings, Ending Balance $ end Balance Sheet Total Assets $ xxx Total Liabilities $ xxx Stockholders’ Equity xxx Retained Earnings end Total Liabilities and Stockholders' Equity $ xxx Income Statement Revenues$ xxx Less: Expenses xxx Net Income$ Net Inc

Stockholders’ Equity Components Common Stock Preferred Stock Additional Paid-in Capital Retained Earnings Treasury Stock

Contributed Capital  Common Stock Basic stock of corporation Normally carries voting rights  Preferred Stock Optional Tailored to meet specific needs

Outstanding: not repurchased or retired Issued: sold or distributed Number of Shares of Stock Authorized Maximum Allowable

Par Value  “Legal capital”  Arbitrary amount stated on stock certificate  Also called “stated value”

Additional Paid-in Capital  Amount received in excess of par when stock was originally issued

Retained Earnings  Net income retained in the business (not paid out as dividends) since its inception  Reinvested in a variety of assets (not necessarily liquid or cash)

IFRS and Stockholders’ Equity  International standards differ from U.S. standards for those items that have attributes of both debt and equity  Convertible stock must be separated into a part that is presented in the Liability section and another part that is presented as Stockholders’ Equity section of the Balance Sheet

Preferred Stock  Can tailor to specific needs of firm  Stated dividend rate Percentage of the stock’s par value Per-share amount  Often carries dividend preference over common stock LO2

Preferred Stock Features  Callable  Convertible  Cumulative  Participating

Stock Issued for Cash Cash 15,000 Common Stock 10,000 Additional Paid-In Capital—Common 5,000 To record the issuance of 1,000 shares of $10 common stock at $15 per share. LO3 1,000 shares of $10 par value stock sold for $15 per share Common Stock $ 10,000 ( $10 par value × 1,000 shares) Additional Paid-In Capital $5,000 ([$15 – $10] × 1,000 shares) Example:

Stock Issued for Noncash Consideration  Record at fair market value of consideration given or received, whichever is more readily determinable Building Common or Preferred Stock

Treasury Stock  Company buys back its own stock  Contra-equity account (debit balance)  Not outstanding (no voting rights) LO4

Reasons for Repurchasing Stock  Provide for employee bonuses or benefit plans  Maintain a favorable market price  Improve financial ratios  Maintain control of ownership  Prevent unwanted takeover or buyout attempts

Presentation of Treasury Stock Common stock, $10 par value, 1,000 shares issued, 900 outstanding $10,000 Additional paid-in capital—Common 12,000 Retained earnings 15,000 Total contributed capital and retained earnings 37,000 Less: Treasury stock, 100 shares at cost ($25 per share) 2,500 Total stockholders’ equity$34,500

Retirement of Stock  Repurchase of stock and is not intended to be resold  A proportional amount of the related Stock and Paid-In Capital accounts must be eliminated

Cash Dividends Paid to Stockholders on date of record Date of declaration Payment date on LO 5

Dividend Requirements  Sufficient cash  Positive retained earnings

Dividend Payout Ratio Annual Dividend Amount Annual Net Income The % of earnings paid as dividends

Dividends Journal entry required to record: (1) dividends declared (2) dividends paid Reduce retained earnings 12/31/101/15/11 Pay dividends

Recording Cash Dividends Retained EarningsXXX Cash Dividend Payable XXX To record the declaration of a cash dividend. Cash Dividend Payable XXX Cash XXX To record the payment of a cash dividend.

Allocation of Common and Preferred Cash Dividends 1. Distribute dividends in arrears, if any, to preferred 2. Distribute current year’s dividends to preferred 3. Distribute remainder to common (or to both if preferred is participating)

Cash Dividends Example Stricker Company declares a $70,000 dividend in 2010 (no dividends were paid in 2008 or 2009). There are 10,000 shares of $10 par, 8% preferred stock and 40,000 shares of $5 par common stock outstanding.

Cash Dividends Example To Preferred To Common Step 1: Distribute current-year dividend to preferred (10,000 shares × $10 par × 8% × 1 year) $8,000 Step 2: Distribute remaining dividend to common ($70,000 – $8,000) $62,000 Total allocated $8,000 $62,000 Noncumulative Preferred Stock $0.80 per share $1.55 per share

Cash Dividends Example To Preferred To Common Step 1: Distribute dividends in arrears to preferred (10,000 shares × $10 par × 8% × 2 years) $16,000 Step 2: Distribute current-year dividend to preferred (10,000 shares × $10 par × 8% × 1 year) 8,000 Step 3: Distribute remainder to common ($70,000 – $24,000) $46,000 Total allocated $24,000 $46,000 Cumulative Preferred Stock $2.40 per share $1.15 per share

Stock Dividends  Reasons: Insufficient cash Market price reduction Nontaxable to recipients  Issue of additional shares proportionately to existing stockholders LO6

Stockholders’ Equity: Common stock, $10 par, 5,000 shares issued and outstanding $ 50,000 Additional paid-in capital—Common 30,000 Retained earnings 70,000 Total stockholders’ equity $150,000 Assume Shah Company declares a 10% stock dividend; 500 $40 per share market value Before Dividend Small Stock Dividend Example

Stockholders’ Equity: Common stock, $10 par, 5,500 shares $ 50,000 $ 55,000 Additional paid-in capital—Common 30,000 45,000 Retained earnings 70,000 50,000 Total stockholders’ equity$150,000 $150,000 $40 market value deducted from retained earnings; allocated between Common Stock (initially Common Stock Dividend Distributable) and Additional Paid-in Capital. Before After Small Stock Dividend Example + + –

Stockholders’ Equity: Common stock, $10 par, 5,500 shares $ 50,000 $ 55,000 Additional paid-in capital—Common 30,000 45,000 Retained earnings 70,000 50,000 Total stockholders’ equity$150,000 $150,000 Before After Small Stock Dividend Example + + – Total S/E is unchanged

Stockholders’ Equity: Common stock, $10 par, 5,000 shares issued and outstanding $ 50,000 Additional paid-in capital—Common 30,000 Retained earnings 70,000 Total stockholders’ equity $150,000 Assume Shah Company declares 100% stock dividend Before Dividend Large Stock Dividend Example

Stockholders’ Equity: Common stock, $10 par, 10,000 shares$ 50,000 $100,000 Additional paid-in capital—Common 30,00030,000 Retained earnings 70,000 20,000 Total stockholders’ equity$150,000 $150,000 Dividend deducted from retained earnings and recorded in the Common Stock account at par. Additional Paid-in Capital account is unaffected. Before After Large Stock Dividend Example + –

Stockholders’ Equity: Common stock, $10 par, 10,000 shares $ 50,000 $100,000 Additional paid-in capital—Common 30,000 30,000 Retained earnings 70,000 20,000 Total stockholders’ equity$150,000 $150,000 Before After Large Stock Dividend Example + – Total S/E is unchanged

Stock Splits  Results in additional issuance of shares  Reduces par value per share  No change in Stockholders’ Equity accounts LO 7

Stock Splits  Not recorded in accounts  Reduce market price per share and make the stock more accessible to a wider range of investors  Disclosed in notes

Stockholders’ Equity: Common stock, $10 par, 5,000 shares issued and outstanding $ 50,000 Additional paid-in capital—Common 30,000 Retained earnings 70,000 Total stockholders’ equity $150,000 Assume Shah Company declares 2-for-1 stock spli t Before Split 2-for-1 Stock Split Example

Stockholders’ Equity: Common stock, $5 par, 10,000 shares $ 50,000 $ 50,000 Additional paid-in capital—Common 30,000 30,000 Retained earnings 70,000 70,000 Total stockholders’ equity$150,000 $150,000 Before After 2-for-1 Stock Split Example All accounts are unchanged Only disclosures are affected

Statement of Stockholders’ Equity  Explains all the reasons for the difference between the beginning and the ending balance of each of the accounts in the Stockholders’ Equity category of the balance sheet Statement of Retained Earnings Beginning retained earnings Add: Net earnings Subtract: Dividend(s) declared = Ending retained earnings LO8

Income Statement For Year Ended December 31, 20XX Revenues xxx Expenses xxx Other gains and losses xxx Income before tax xxx Income tax expense xxx Net income xxx Statement of Comprehensive Income For Year Ended December 31, 20XX Net incomexxx Foreign currency translation adjustmentxxx Unrealized holding gains/lossesxxx Minimum pension liability adjustmentxxx Other comprehensive incomexxx Comprehensive incomexxx Comprehensive income: The total change in net assets from all sources except investments by or distributions to the owners

Analyzing Stockholders’ Equity  Book value per share Rights that each share of common stock has to the net assets of corporation  Market value per share Price at which stock is currently selling LO9

Book Value per Share  Amount per share of net assets to which the company’s common stockholders have the rights  Does not indicate the price that should be paid by those who want to buy or sell the stock on the stock exchange Total Stockholders’ Equity Number of Shares of Stock Outstanding

Market Value per Share  The selling price of the stock as indicated by the most recent transactions  Usually stated in a 52-week high and low  More meaningful measure of the value of the stock than book value 52-week Daily High LowSymHighLow Last Change GM (1.13%)

Stockholders’ Equity Items on the Statement of Cash Flows Operating Activities Net income xxx Investing Activities Financing Activities Issuance of stock + Retirement or repurchase of stock – Payment of dividends – LO10

Appendix Accounting Tools: Unincorporated Businesses

Sole Proprietorships  Not a separate legal entity so owner has unlimited liability  Must keep personal and business records separate  Business income is declared on the owner’s personal tax return and taxed at personal tax rate LO11

Sole Proprietorships Owner’s withdrawal of an auto from the business: Peter Tom, Drawing 6,000 Equipment 6,000 To record the withdrawal of an auto from the business. Owners’ drawing or withdrawal accounts are contra-equity accounts

Sole Proprietorships  Drawing or withdrawal and income summary accounts are closed to the owner’s capital account  Owner’s Equity section of the balance sheet consists of the capital account: Beginning balance$ 0 Plus: Investments 10,000 Net Income 4,000 Less: Withdrawals (6,000) Ending balance $ 8,000

Partnerships  Unlimited liability  Limited life—partnership agreements can and do end  Not taxed as a separate entity

Partnerships Distribution of income:  Equal distribution  Stated ratio  Other allocation For example, based on salaries, interest on invested capital, and a stated ratio

End of Chapter 11