©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Stockholders’ Equity Chapter 9

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren IHOP Corp. Stockholders’ Equity Preferred stock, $1 par value, 10,000 shares authorized; shares issued and outstanding; 2000 and 1999, none – – Common stock, $.01 par value, 40,000,000 shares authorized: 2000; 20,299,091 shares issued and 20,011,240 shares outstanding 1999; 20,117,314 shares issued and outstanding$203$201 ( In thousands, except shares amounts) December

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren IHOP Corp. Stockholders’ Equity Additional paid-in capital 69,655 66,485 Retained earnings 193, ,294 Treasury stock, at cost (2000; 287,750 shares; 1999; none (5,170) – Other 1,675 1,500 Total shareholders’ equity$259,995$226,480 ( In thousands, except shares amounts) December

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Learning Objective 1 Explain the advantages and disadvantages of a corporation.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren What is the Best Way to Organize a Business? Proprietorship Partnership Corporation

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Characteristics of a Corporation Separate legal entity Continuous life and transferability of ownership Limited liability Separation of ownership and management Corporate taxation Government regulation

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Advantages and Disadvantages of a Corporation 1. Separation of ownership 2. Corporate taxation 3. Government regulation Disadvantages 1. Can raise more capital than a proprietorship or partnership can 2. Continuous life 3. Ease of transferring ownership 4. Limited liability of stockholders Advantages

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Organizing a Corporation Charter Incorporators Set bylaws

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Authority Structure of a Corporation Stockholders Board of Directors Chairperson of the Board (CEO) President (Chief Operating Officer)

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Authority Structure of a Corporation President (Chief Operating Officer) VP Sales VP Manufacturing CFO VP Personnel Secretary Controller (Accounting Officer) Treasurer (Finance Officer)

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Stockholders’ Rights Vote Dividends Liquidation Preemption

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Stockholders’ Equity Paid-in capital (contributed capital) Retained earnings Owners’ equity in a corporation has two main components:

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Capital Stock Corporate ownership is evidenced by a stock certificate which may be for any number of shares. The total number of shares authorized is limited by charter.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Capital Stock Common Stock The most basic form of capital stock issued by every corporation. Preferred Stock A class of stock that has several preferences over common stock.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Capital Stock Par Value Stock It is an arbitrary amount assigned by a company to a share of its stock. No-par Stock Does not have a par value, but may have a stated value (an arbitrary amount).

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Learning Objective 2 Measure the effect of issuing stock on a company’s financial position.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Issuing Stock Corporations need money to operate from sources other than borrowing. They sell (issue) stock directly to the stockholders or use the service of an underwriter.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Common Stock at Par Suppose IHOP’s common stock carries a par value of $10 per share. The company issues 6,200,000 shares of common stock at par. What is the entry?

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Common Stock at Par January 8 Cash (6,200,000 × $10)62,000,000 Common Stock62,000,000 To issue common stock

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Common Stock Above Par IHOP’s common stock has a par value of $0.01 per share. The company issues 6,200,000 shares of common stock at $10 per share. What is the entry?

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Common Stock Above Par July 23 Cash (6,200,000 × $10) 62,000,000 Common Stock (6,200,000 × $0.01) 62,000 Paid-in Capital in Excess of Par – Common (6,200,000 × $9.99) 61,938,000 To issue common stock

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Common Stock Above Par Common Stock, $.01 par; 40 million shares authorized, 6.2 million shares issued$ 62,000 Paid-in capital in excess of par 61,938,000 Total paid-in capital$ 62,000,000 Retained earnings 194,000,000 Total stockholders’ equity$256,000,000 Stockholders’ Equity

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren No-Par Common Stock When a company issues no-par stock, it debits the asset received and credits the stock account. August 14 Cash (3,000 × $20)60,000 Common Stock60,000 To issue no-par common stock

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Preferred Stock Accounting for preferred stock follows the pattern illustrated for common stock. Stockholders’ equity on the balance sheet lists preferred stock, common stock, and retained earnings – in that order.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Ethical Considerations Issuing stock for assets other than cash can pose an ethical challenge. The company issuing the stock often wishes to record a large amount for the noncash asset received and for the stock that it is issuing.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Learning Objective 3 Describe how treasury stock transactions affect a company.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Treasury Stock Transactions Treasury stock are shares that a company has issued and later reacquired. Stock purchase plan distribution Increase net assets Avoidance of a takeover Reasons for purchasing their own stock:

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren IHOP Corp. Before Purchase of Treasury Stock Common Stock$ 203 Paid-in capital in excess of par 69,655 Retained earnings 193,632 Total equity$263,490 Stockholder’s Equity at December 31, 2000 (if no treasury stock purchased – $000)

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren IHOP Corp. Purchase of Treasury Stock November 12, 2000 Treasury Stock5,170 Cash5,170 Purchased treasury stock November 12, 2000 Treasury Stock5,170 Cash5,170 Purchased treasury stock During 2000, IHOP paid $5,170 to purchase 288 shares of its common stock as treasury stock. During 2000, IHOP paid $5,170 to purchase 288 shares of its common stock as treasury stock. ($000)

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren IHOP Corp. After Purchase of Treasury Stock Common Stock$ 203 Paid-in capital in excess of par 69,655 Retained earnings 193,632 Less: Treasury stock (288 shares at cost) – 5,170 Total equity$258,320 Stockholder’s Equity at December 31, 2000 (with treasury stock purchased – $000)

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Sale of Treasury Stock Assume that on July 22, 2002, the shares of treasury stock are sold for $5,300. Assume that on July 22, 2002, the shares of treasury stock are sold for $5,300. Cash5,300 Treasury Stock5,170 Paid-In Capital from Treasury Stock Transactions 130 Sold treasury stock Cash5,300 Treasury Stock5,170 Paid-In Capital from Treasury Stock Transactions 130 Sold treasury stock

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren IHOP Corp. After Sale of Treasury Stock Common Stock$ 203 Paid-in capital in excess of par 69,785 Retained earnings 193,632 Total equity$263,620 Equity before purchase of treasury stocks 263,490 Increase in stockholders’ equity$ 130 Stockholder’s Equity at December 31, 2002 ($000)

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Retirement of Stock It decreases the outstanding stock of the corporation. Retired shares cannot be reissued. There is no gain or loss on retirement.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Retained Earnings, Dividends, and Splits The Retained Earnings account carries the balance of the business’s net income less its net losses and less any declared dividends accumulated over the corporation's lifetime.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Retained Earnings, Dividends, and Splits A dividend is a corporation’s return to its stockholders of some of the benefits of earnings. A stock split is an increase in the number of authorized, issued, and outstanding shares.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Dividend Dates Declaration date Date of recordPayment date Three relevant dates for dividends are:

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Learning Objective 4 Account for dividends and measure their impact on a company.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Preferred Stock Dividends When a company has issued both preferred and common stock, the preferred stockholders receive their dividends first. When a company has issued both preferred and common stock, the preferred stockholders receive their dividends first. Pinecraft Industries, Inc., has both common stock and 90,000 shares of preferred stock outstanding. Pinecraft Industries, Inc., has both common stock and 90,000 shares of preferred stock outstanding.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Preferred Stock Dividends Preferred dividend (90,000 × $1.75 per share) $157,500 Common dividend (remainder: $1,500,000 – $157,500) 1,342,500 Total dividend$1,500,000 Preferred dividends are paid at the annual rate of $1.75 per share. Assume that in 2004, the company declares an annual dividend of $1,500,000.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Expressing the Dividend Rate on Preferred Stock Percentage rate Dollar amount

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Preferred Stock Dividends The preferred stock of Pinecraft is cumulative. Retained Earnings500,000 Dividends Payable, Preferred315,000* Dividends Payable, Common ($500,000 – $315,000)185,000 To declare a cash dividend *($157,500 × 2 years) Suppose the company passed the 2004 preferred dividend of $157,500. In 2005, the company declares a $500,000 dividend.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Why Issue a Stock Dividend? To continue dividends but conserve cash To reduce the per-share market price of its stock Small stock dividends: 25% or less Large stock dividends: above 25%

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Stock Dividend IHOP declared a 10% stock dividend in The stock is trading for $15 per share. How would this stock dividend be recorded? Assume IHOP had 20,000,000 shares of common stock outstanding.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Stock Dividend Retained Earnings (20,000,000 × 10% × $15)30,000,000 Common Stock (20,000,000 × 10% × $0.01) 20,000 Paid-in Capital in Excess of Par Common29,980,000 Distributed a 10% stock dividend For a large stock dividend, debit Retained Earnings and credit Common Stock for the par value of the shares.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Stock Splits A stock split is an increase in the number of authorized, issued, and outstanding shares of stock, coupled with a proportionate reduction in the stock’s par value. A stock split decreases the market price of stock.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Stock Splits The market price of a share of Quaker Oats has been approximately $25. This 2-for-1 split means that the company would have twice as many shares outstanding after the split as is had before the split. Assume that the company wants to decrease it to $12.50.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Learning Objective 5 Use different stock values in decision making.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Stock Values Market value Redemption value Liquidation value Book value

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Book Value Book value per share of preferred stock = (Redemption value + Dividends in arrears) ÷ Number of shares of preferred outstanding Book value per share of common stock = (Total stockholders’ equity – Preferred equity) ÷ Number of shares of common stock outstanding

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Book Value Preferred stock, 6%, $100 par, 5,000 shares authorized, 400 shares issued, redemption value $130 per share$ 40,000 Additional paid-in capital in excess of par – preferred 4,000 Common stock, $10 par, 20,000 shares authorized, 5,500 shares issued 55,000 Additional paid-in capital in excess of par – common 72,000 Retained earnings 85,000 Treasury stock – common, 500 shares at cost – 15,000 Total stockholders’ equity$241,000 Stockholders’ Equity Assume that a company’s balance sheet reports the following:

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Book Value Suppose that four years’ (including the current year) cumulative preferred dividends are in arrears and that preferred stock has a redemption value of $130 per share. The book-value-per-share computations for this company are as follows:

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Book Value Preferred equity: Redemption value (400 shares × 130)$ 52,000 Cumulative dividends ($40,000 × $0.06 × 4 years) 9,600 Preferred equity$ 61,600 Common equity: Total stockholders’ equity$241,000 Less preferred equity – 61,600 Common equity$179,400 Book value per share: $179,400 ÷ 5,000 shares*$ *5,500 shares issued minus 500 treasury shares

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Learning Objective 6 Evaluate a company’s return on assets and return on stockholders’ equity.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Return on Assets Rate of return on total assets = (Net income + Interest expense) ÷ Average total assets It is a measure of a company’s ability to generate profits from the use of its assets.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Return on Equity Rate of return on common stockholders’ equity = (Net income – Preferred dividends) ÷ Average common stockholders’ equity It is a measure of the income earned from the common stockholders’ investment in the company.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Return on Equity IHOP’s return on equity (14.5%) is higher than its return on assets (10.5%). This difference results from the interest-expense component of return on assets.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Learning Objective 7 Report stockholders’ equity transactions on the statement of cash flows.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Reporting Stockholders’ Equity Transactions Proceeds from issuance of common stock$ 172,000 Purchase of treasury stock (5,170,000) Net cash used by financing activities$(4,998,000) During 2000, IHOP issued stock, repurchased stock, but paid no dividends. Following is their report of cash flows from financing activities illustrating the effect on their stockholders’ equity.

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Variations in Reporting Stockholders’ Equity Preferred stock, 8%, $10 par, 30,000 shares authorized and issued300,000 Paid-in capital in excess of par – preferred 10,000 General Teaching Format Stockholders’ equity (Paid-in capital) Real-World Format Stockholders’ equity Preferred stock, 8%, $10 par, 30,000 shares authorized and issued310,000

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Variations in Reporting Stockholders’ Equity Paid-in capital in excess of par – common2,140,000 Paid-in capital from treasury stock transactions, common 9,000 Paid-in capital from retirement of preferred stock 11,000 General Teaching Format Stockholders’ equity (Paid-in capital) Real-World Format Stockholders’ equity Additional paid-in capital2,160,000

©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren End of Chapter 9