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1 Stockholders’ Equity ACG 2021 Financial Accounting.

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1 1 Stockholders’ Equity ACG 2021 Financial Accounting

2 2 Characteristics of a Corporation Separate legal entity Exists separately from owners Can enter in contracts, sue or be sued Continuous life Change of ownership does not end Corporate life Ownership can be transferred Limited liability Only Corporate debts No personal obligation for corporate liabilities

3 3 Characteristics of a Corporation Separation of ownership and management Stockholders own the corporation Elect Board of Directors Sets Policies and appoints officers  Elect Chairperson (CEO)  Elect President (COO)  In charge of day-to-day operations Corporate taxation Franchise Tax (some states) Corporate Taxes on Income Double Taxation  Corporation is Taxed on Earnings  Individuals are taxed on dividends from earnings Government regulation Disclosure of Information for Stakeholders (Investors, Creditors, Taxing Authorities, etc.) to make informed decisions Accounting

4 4 Advantages of a Corporation 1.Can raise more capital than a proprietorship or partnership can 2.Continuous life 3.Ease of transferring ownership 4.Limited liability of stockholders

5 5 Disadvantages of a Corporation 1. Separation of ownership 2. Corporate taxation 3. Government regulation

6 6 Stockholders Board of Directors Chairperson of the Board President Authority Structure of a Corporation

7 7 Vote Dividends Liquidation Preemption Stockholders’ Rights

8 8 Stockholders Rights Unless Withheld by Agreement Voting One Vote for each share owned Dividends Right to Receive proportionate share Liquidation Right to Receive proportionate share of Net Assets Preemption Right to Maintain one’s proportionate ownership  Usually withheld from stockholders

9 9 ACG 2021 Financial Accounting Stockholder’s Equity Section of the Balance Sheet

10 10 Stockholders’ Equity Two main components: Paid-in capital (contributed capital) Amount contributed by stockholders Stock (At Par) Additional Paid in Capital Retained earnings Equity Earned but not paid in Dividends

11 11 What is Par Value The par value of a stock was the share price upon initial offering; the issuing company promised not to issue further shares below par value, so investors could be confident that no one else was receiving a more favorable issue price. This was far more important in unregulated equity markets than in the regulated markets that exist today.initial offering Quoted from Wikipedia at alue Most common stocks issued today do not have par values; those that do (usually only in jurisdictions where par values are required by law) have extremely low par values, for example a penny par value on a stock issue at USD$25/share.common stocks USD

12 12 Capital Stock Authorized shares Total # of Shares available for sale Outstanding shares Total # of Shares actually sold Represents 100% ownership Often Less than shares authorized

13 13 Types of Capital Stock Common Stock Residual Equity Holder Paid Dividends after Preferred Stockholders After Creditors & Preferred Stockholders are satisfied, Common stockholder receives liquidation Dividends are not subject to Limit Voting Rights (controls the corporation)

14 14 Types of Capital Stock Preferred Stock Rights and Privileges Current Dividend Preference  May be in Arrears  Though in Arrears is not a liability Dividends are still discretionary

15 15 Dividend Example Assumptions: Preferred Stock is 6%, $100 par value, two years in arrears, 1000 Shares outstanding; common stock is $10 par, 1000 shares outstanding CaseDividend DeclaredNon-Cumulative PfdCommon A1000 0 B700060001000 C1300060007000 D19000600013000 Cumulative PfdCommonArrears A1000 017000 B7000 011000 C13000 05000 D19000180001000

16 16 ACG 2021 Financial Accounting Accounting for Issuance of Common Stock and Re-purchase of Treasury Stock

17 Common Stock at Par Jan 8Cash (6,200 x $10)62,000 Common Stock62,000 To record issuance of stock Suppose IHOP’s common stock has a par value of $10 per share. The company issues 6,200 shares of common stock at par. What is the entry?

18 Common Stock above Par Jul 23Cash (6,200 x $10)62,000 Common Stock62 Paid-in Capital in Excess of Par61,938 To record issuance of stock Suppose IHOP’s common stock has a par value of $0.01 per share. The company issues 6,200 shares of common stock for $10 per share. What is the entry?

19 Balance Sheet Common Stock Above Par Common Stock, $.01 par; 40,000 shares authorized, 6,200 shares issued$ 62 Paid-in capital n excess of par 61,938 Total paid-in capital$ 62,000 Retained earnings 194,000 Total stockholders’ equity$256,000 Stockholders’ Equity

20 Common Stock at Par Suppose IHOP’s common stock is no par value stock. The company issues 6,200 shares of common stock for $20 per share. What is the entry? Jul 23Cash (6,200 x $20)124,000 Common Stock124,000 To record issuance of stock

21 21 Preferred Stock Accounting for preferred stock follows the pattern illustrated for common stock.

22 22 Treasury Stock Transactions Shares that a company has issued and later reacquired. Shares needed for Employee Stock Plan Distribution Increase net assets Buy Low, Sell High Avoidance of a takeover Contra Stockholder Equity

23 23 IHOP Corp. Before Purchase of Treasury Stock Common Stock$ 203 Paid-in capital in excess of par69,655 Retained earnings 193,632 Total equity$263,490 Stockholder’s Equity at December 31, 2005 (if no treasury stock purchased)

24 IHOP Corp. Purchase of Treasury Stock During 2005, IHOP paid $5,170 to purchase 288 shares of its common stock as treasury stock. Nov 1Treasury Stock5,170 Cash5,170 Purchased treasury stock

25 IHOP Corp. After Purchase of Treasury Stock Common Stock$ 203 Paid-in capital in excess of par69,655 Retained earnings193,632 Less: Treasury stock (288 shares at cost) (5,170) Total equity$258,320 Stockholder’s Equity at December 31, 2005 (with treasury stock purchased)

26 Sale of Treasury Stock Assume that on July 22, 2006, the shares of treasury stock are sold for $5,300. Jul 22Cash5,300 Treasury Stock5,170 Paid-in Capital from Treasury Stock Transactions130 Sold treasury stock (Loss would require debit of retained earnings)

27 IHOP Corp. After Sale of Treasury Stock Common Stock$ 203 Paid-in capital in excess of par69,785 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, 2006

28 28 Retirement of Stock Decreases the outstanding stock of the corporation Retired shares cannot be reissued There is no gain or loss on retirement

29 29 Equity Transactions on the Cash Flow Statement 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 2003, IHOP issued stock, repurchased stock, but paid no dividends. Cash flows from financing activities:

30 30 ACG 2021 Financial Accounting Retained Earnings and Dividends

31 31 Retained Earnings Is Not Cash Is Not a Reserve held for Dividends Is the account used to Record Cash Dividends Stock Dividends Is Profits Reinvested into Corporation Credit Balance = Earnings > Losses + Dividends Debit Balance (Deficit) = Earnings < Losses + Dividends

32 32 Dividends and Splits Dividend - corporation’s return to its stockholders of some of the benefits of earnings Cash or Stock Stock split - increase in the number of authorized, issued, and outstanding shares

33 33 Dividend Dates Declaration date BOD announces dividend Date of record Stockholders who own stock by this date will receive dividend Payment date When dividend is paid

34 Preferred Stock Dividends The preferred stock of Pinecraft is cumulative. Suppose the company passed the 20x6 preferred dividend of $150,000. In 20x7, the company declares a $500,000 dividend. Retained Earnings500,000 Dividends Payable-Preferred300,000* Dividends Payable-Common200,000 Declared a cash dividend *$150,000 x 2 years

35 35 Stock Dividend IHOP declared a 10% stock dividend in 2006. Assume IHOP had 20,000,000 shares of common stock outstanding. The stock is trading for $15 per share. How would this stock dividend be recorded?

36 Stock Dividend Retained Earnings (20,000,000 X 10% X $15)30,000 Common Stock (20,000,000 X 10% X $0.01) 20 Paid-in Capital in Excess of Par Common29,980 Distributed a 10% stock dividend

37 37 Stock Splits Corporations like stock prices within a specific trading range Higher prices might discourage small investors The more widely held a stock (small and large investors) the less volatile the market pricing may be Thus, stock splits are used to reduce the market price by Increasing the number of authorized, issued, and outstanding shares of stock Proportionate reduction in stock’s par value Decreasing market price

38 38 Stock Split Example

39 39 ACG 2021 Financial Accounting Stock Valuations

40 40 Stock Values Market value Market Price Redemption value Set price for Preferred stock Not Equity but a liability Liquidation value Amount paid to Preferred stockholders in case the company liquidates Book value Amount of Stockholders Equity per outstanding share

41 41 Book Value Per Share Preferred stock = (Redemption value + Dividends in arrears) ÷ Number of shares of preferred outstanding Common stock = (Total stockholders’ equity – Preferred equity) ÷ Number of shares of common stock outstanding

42 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 issued55,000 Additional paid-in capital in excess of par – common72,000 Retained earnings85,000 Treasury stock – common, 500 shares at cost ( 15,000) Total stockholders’ equity$241,000 Stockholders’ Equity

43 43 Book Value Common Stock 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.

44 44 Book Value – Preferred Stock Preferred equity: Redemption value (400 shares × 130) $ 52,000 Cumulative dividends ($40,000 × $0.06 × 4 yrs) 9,600 Preferred equity $ 61,600 61,600 / 400 = $154.00

45 Book Value Common Stock Preferred equity: Redemption value (400 shares × 130)$ 52,000 Cumulative dividends ($40,000 × $0.06 × 4 yrs) 9,600 Preferred equity$ 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* $ 35.88 *5,500 shares issued minus 500 treasury shares

46 46 ACG 2021 Financial Accounting Ratios: Return on Assets and Return on Equity

47 47 Ratio Definitions Return on Assets Measure of a company’s ability to generate profits from the use of its assets (Net income + Interest expense) ÷ Average total assets Return on Equity Measure of income earned from common stockholders’ investment in the company (Net income – Preferred dividends) ÷ Average common stockholders’ equity

48 48 End of Chapter 9

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