1. Electronic Presentation by Douglas Cloud Pepperdine University
Chapter 11
Stockholders’ Equity: Capital Stock and Dividends
Electronic Presentation by Douglas Cloud Pepperdine University

2. After studying this chapter, you should be able to:
Learning Goals
1. Describe the nature of the corporate form of organization.
2. List the major sources of paid-in capital, including the various classes of stock.
3. Describe the financial statement effects of issuing stock.
4. Describe the financial statement effects of treasury stock transactions.
After studying this chapter, you should be able to:
Continued

3. Learning Goals
5. Describe the effect of stock splits on the financial statements.
6. Analyze the impact of issuing common stock on bonds.
7. Describe the financial statement effects of cash dividends and stock dividends.
8. Compute and interpret the dividend yield and dividend payout ratio on common stock.
9. Describe financial statement presentations of stockholders’ equity.

4. Learning Goal 1
Describe the nature of the corporate form of organization.

5. Characteristics of a Corporation
Advantages
Separate legal existence
Continuous life
An ability to raise large amounts of capital
Owners can transfer ownership rights without affecting the corporation
Limited liability

6. Characteristics of a Corporation
Disadvantages
Owner is separate from management
Double taxation of dividends

7. Organizational Structure of a Corporation
Stockholders
(owners of corporation stock)
Board of Directors
(elected by stockholders)
Officers
(selected by board of directors)
Employees

8. Forming a Corporation
First step is to file an application of incorporation with the state.
Because state laws differ, corporations often organize in states with more favorable laws.
More than half of the largest companies are incorporated in Delaware.
State grants a charter or articles of incorporation which formally create the corporation.
Management and board of directors prepare bylaws which are operation rules and procedures.

9. Learning Goal 2
List the major sources of paid-in capital, including the various classes of stock.

10. Major Rights that Accompany Ownership of a Share of Stock
1. The right to vote in matters concerning the corporation.
2. The right to share in distribution of earnings.
3. The right to share in assets on liquidation.

11. Sources of Paid-In Capital
Authorized
Issued
Outstanding
Number of Shares

12. Market for Common Stock
Types of stock market transactions
An initial public offering (IPO)
Additional shares sold by an established public company
Market exchanges between owners of a publicly held company

13. Classes of Stockholders
The two primary classes of paid-in capital are common stock and preferred stock. The primary attractiveness of preferred stocks is that they are preferred over common as to dividends.
Preferred stockholder

14. Classes of Stockholders
Common Stock – the basic ownership of stock with rights to vote in election of directors, share in distribution of earnings, and purchase additional shares.
Preferred Stock – A class of stock with preferential rights over common stock in payment of dividends and company liquidation.

15. Cumulative Preferred Stock
So, preferred dividends are two years in arrears.
Assume 1,000 shares of $4 cumulative preferred stock and 4,000 shares of common stock. No dividends have been paid in the preceding two years.

16. Cumulative Preferred Stock
On March 7, 2005, the board of directors declares dividends of $22,000.

17. Cumulative Preferred Stock
Preferred Stock Dividends
Dividends Paid in 2005
Total dividends paid, $22,000
$4,000
2003
(In arrears)
$4,000
$10,000
$4,000
2004
(In arrears)
$4,000
$4,000
2005
(Current dividend)
$4,000
Preferred Stock
Common Stock

18. Learning Goal 3
Describe the financial statement effects of issuing stock.

19. Issuing Stock
A corporation issues 5,000 shares of preferred stock, $100 par, and 50,000 shares of common stock, $20 par.
Cash 1,500,000
Preferred Stock 500,000
Common Stock 1,000,000

20. Premium on Stock
Stock issued for assets other than cash should be recorded at the fair market value of the asset or fair market value of the stock, whichever can be more clearly determined.
FAIR VALUE

21. Premium on Stock
Caldwell Company issues 2,000 shares of $1 par common stock for cash at $55.
Cash 110,000
Common Stock 2,000
Paid-in Capital in Excess of
Par—Common Stock 108,000

22. Premium on Stock
Archer Company issues 10,000 shares of its $10 par preferred stock for land. The land’s fair market value cannot be determined and the stock has a current market value of $12 per share.
10,000 x $12
Land 120,000
Preferred Stock 100,000
Paid-in Capital in Excess of
Par—Preferred Stock 20,000

23. No-Par Common Stock
Also, no-par stock may be assigned a stated value per share. The stated value is recorded like a par value.

24. No-Par Common Stock
Fargo Company issues 10,000 shares of its no-par common stock at $40 a share, and at a later date issues 1,000 additional shares at $36.
Cash 400,000
Common Stock 400,000
Cash 36,000
Common Stock 36,000

25. No-Par Common Stock
Some states require that the entire proceeds from the sale of no-par stock be treated as legal capital.

26. No-Par Common Stock
Fargo Company issues 10,000 shares of its no-par common stock at $40 a share, and at a later date issues 1,000 addition shares at $36. The stated value is $25 per share.
Cash 36,000
Common Stock 25,000
Paid-In Capital in Excess of
Stated Value 11,000
Cash 400,000
Common Stock 250,000
Paid-In Capital in Excess of
Stated Value 150,000

27. Learning Goal 4
Describe the financial statement effects of treasury stock transactions.

28. Treasury Stock Transactions
Occasionally, a corporation buys back its own stock for the purpose of later reissuing it. This stock is referred to as treasury stock.

29. Treasury Stock Transactions
Earlier, Elrod Corporation issued 20,000 shares of its $25 par common stock at $32.50 a share. Elrod repurchased 1,000 shares as treasury stock at $45 per share.
Treasury Stock 45,000
Cash 450,000
Continued

30. Treasury Stock Transactions
Later, 200 shares of the treasury stock were resold for $60 per share.
Cash 12,000
Treasury Stock 9,000
Paid-In Capital from Sale of
Treasury Stock 3,000
Continued

31. Treasury Stock Transactions
Later, another 200 shares of the treasury stock are for $40 per share.
Cash 8,000
Paid-In Capital from Treasury Stock 1,000
Treasury Stock 9,000
Remember: Treasury stock is not an asset!

32. Treasury Stock Transactions
Stockholders’ Equity
Paid-in capital:
Common stock, $25 par
(20,000 shares authorized and issued) $500,000
Excess of issue price over par 150,000
From sale of treasury stock 2,000
Total paid-in capital $652,000
Retained earnings 130,000
Total $782,000
Deduct treasury stock (600 shares at cost) 27,000
Total stockholders’ equity $755,000
Debit balance of Treasury Stock account.

33. Learning Goal 5
Describe the effect of stock splits on the financial statements.

34. Stock Splits
A corporation sometimes reduces the par or stated value of their common stock and issues a proportionate number of additional shares. This is called a stock split.

35. Stock Splits 20 shares, $20 par AFTER 5-1 STOCK SPLIT
BEFORE STOCK SPLIT
4 shares, $100 par
$400 total par value
$400 total par value

36. Learning Goal 6
Analyze the impact of issuing common stock or bonds.

37. Common Stock Financing
Earnings before interest and
taxes—base case (EBIT) $1,220,000
Return on investment
(12% x $1,500,000) ,000
Earnings before taxes $1,400,000
Income tax 40%) ,000
Net income $ 840,000
Base number of shares outstanding 500,000
Plus additional shares issued 100,000
Total shares outstanding 600,000
Earnings per share (EPS) $1.40

38. Bond Financing Earnings before interest and
taxes—base case (EBIT) $1,220,000
Return on investment
(12% x $1,500,000) ,000
Interest on bonds (10% x $1,500,000) (150,000)
Earnings before taxes $1,250,000
Income tax 40%) ,000
Net income $ 750,000
Base number of shares outstanding 500,000
Total shares outstanding 500,000
Earnings per share (EPS) $1.50

39. No Financing Earnings before taxes $1,220,000
Income tax 40%) ,000
Net income $ 732,000
Base number of shares outstanding 500,000
Total shares outstanding 500,000
Earnings per share (EPS) $1.464

41. Learning Goal 7
Describe the financial statement effects of cash dividends and stock dividends.

42. Accounting for Cash Dividends
Cash dividends are declared and paid on shares outstanding with three conditions:
1. Sufficient retained earnings
2. Sufficient cash
3. Formal action by the board of directors
Retained Earnings
50,000

43. Accounting for Cash Dividends
There are three important dates relating to dividends.

44. Accounting for Cash Dividends
First is the date of declaration. Assume that on December 1, Hiber Corporation declares a $42,500 dividend.

45. Accounting for Cash Dividends
Date of Declaration
Dec. 1 Retained Earnings 42,500
Cash Dividends Payable 42,500

46. Accounting for Cash Dividends
The second important date is the date of record. For Hiber Corporation, this would be December 11.

47. Accounting for Cash Dividends
On this date, ownership of shares determines who receives the dividend. No entry is required.

48. Accounting for Cash Dividends
Date of Declaration
Dec. 1 Retained Earnings 42,500
Cash Dividends Payable 42,500
Date of Record
No entry

49. Accounting for Cash Dividends
The third important date is the date of payment. On January 2, Hiber issues dividend checks. 2

50. Accounting for Cash Dividends
Date of Declaration
Dec. 1 Retained Earnings 42,500
Cash Dividends Payable 42,500
Date of Record
No entry
Date of Declaration
Jan. 2 Cash Dividends Payable 42,500
Cash 42,500

51. Accounting for Stock Dividends
A distribution of shares to stockholders is called a stock dividend.

52. Accounting for Stock Dividends
Stock dividends transfer pro rata shares of stock to stockholders. On December 15, Hendrix Corporation issues a 5% stock dividend on common stock, $20 par, 2,000,000 shares issued.

53. Hendrix Corporation, December 15 (before dividend)
Accounting for Stock Dividends
Hendrix Corporation, December 15 (before dividend)
Common Stock, $20 par $40,000,000
Paid-in Capital in Excess of Par--Common Stock 9,000,000
Retained Earnings 26,600,000
Dec. 15 Retained Earnings 3,100,000
Stock Dividend
Distributable 2,000,000
Paid-In Capital in
Excess of Par—
Common Stock 1,100,000
100,000 shares x $31 market price
100,000 shares x $20 par value

54. Accounting for Stock Dividends
On January 10, Hendix Corporation issues the stock. This action increases the number of shares outstanding by 100,000.
Jan. 10 Stock Dividends
Distributable 2,000,000
Common Stock 2,000,000

55. Hendrix Corporation, December 15 (before dividend)
Accounting for Stock Dividends
Hendrix Corporation, December 15 (before dividend)
Common Stock, $20 par $40,000,000
Paid-in Capital in Excess of Par—Common Stock 9,000,000
Retained Earnings ,600,000
$75,600,000
Hendrix Corporation, January 10 (after dividend)
Common Stock, $20 par $42,000,000
Paid-in Capital in Excess of Par—Common Stock 10,100,000
Retained Earnings 23,500,000
$75,600,000

56. Learning Goal 8
Compute and interpret the dividend yield and dividend payout ratio on common stock.

57. Profitability Measures —The Common Stockholder
Dividends per share of common $ $ 0.60
Market price per share of common $20.50 $13.50
Cash Dividends per Share of Common Stock
Market Price per Share of Common Stock
Dividend Yield
$.60
$13.50
Dividend Yield, 2004
= 4.4%
$.80
$20.50
= 3.9%
Dividend Yield, 2005

58. Profitability Measures —The Common Stockholder
The purpose of the dividend yield ratio is to indicate the rate of return to common stockholders in terms of dividends

59. Profitability Measures —The Common Stockholder
Cash dividends per share $0.80 $0.60
Annual earnings per share $7.50 $5.80
Annual Cash Dividend per Share
Annual Earnings per Share
Dividend Payout
Ratio
$.60
$5.80
Dividend Payout
Ratio, 2004
= 10.3%
$.80
$7.50
Dividend Payout
Ratio, 2005
= 10.7%

60. Profitability Measures —The Common Stockholder
The dividend payout ratios indicate that the firm paid out slightly more than 10 percent of its annual earnings in dividends.

61. Learning Goal 9
Describe financial statement presentations of stockholders’ equity.

62. Most corporations report changes in retained earnings by preparing a separate “retained earnings” column in the statement of stockholders’ equity.

63. Make a note to examine Exhibit 8 in the textbook
Make a note to examine Exhibit 8 in the textbook. It shows the statement of stockholders’ equity for Outback Steakhouse, Inc.

64. Chapter 11
The End