University of California, Santa Barbara

University of California, Santa Barbara
Prepared by Coby Harmon University of California, Santa Barbara Westmont College Copyright ©2015 Pearson Education Inc. All rights reserved.

FEATURES OF A CORPORATION Advantages Disadvantages Can raise more capital than a proprietorship or partnership can Continuous life Ease of transferring ownership Limited liability of stockholders Separation of ownership and management Double taxation of distributed profits Government regulation Exhibit 10-1 | Advantages and Disadvantages of a Corporation LO 1 Copyright ©2015 Pearson Education Inc. All rights reserved.

Organizing a Corporation Corporate organizers (incorporators) obtain a charter from the state Charter includes authorization to issue shares of stock Incorporators: Pay fees Sign the charter File documents with the state Agree to set of bylaws LO 1 Copyright ©2015 Pearson Education Inc. All rights reserved.

Stockholders’ Rights Vote Right to voting on matters that come before the stockholders Dividends Right to receive a proportionate part of any dividend Right to receive a proportionate share of any assets remaining after corporation pays its liabilities in liquidation Liquidation Preemption Right to maintain one’s proportionate ownership in the corporation LO 1 Copyright ©2015 Pearson Education Inc. All rights reserved.

Stockholders’ Equity Paid-in Capital Retained Earnings Also called contributed capital Amount of equity stockholders have contributed Includes stock accounts and any additional paid- in capital Increased by earnings through profitable operations Reduced by dividends declared LO 1 Copyright ©2015 Pearson Education Inc. All rights reserved.

Classes of Stock Common Preferred Basic form of stock Has four basic rights Shareholders benefit most if corporation succeeds Take more risk Advantages Receive dividends first Receive assets first in liquidation Shareholders earn a fixed dividend Few corporations issue LO 1 Copyright ©2015 Pearson Education Inc. All rights reserved.

Exhibit 10-4 | Percentage of Corporations Issuing Preferred Stock Classes of Stock Exhibit 10-5 | Comparison of Common Stock, Preferred Stock, and Long-Term Debt LO 1 Copyright ©2015 Pearson Education Inc. All rights reserved.

Par Value and No-Par Arbitrary amount assigned to share of stock Usually set low to avoid legal issues Most states do not allow companies to issue stock below par No-par stock May have a stated value LO 1 Copyright ©2015 Pearson Education Inc. All rights reserved.

ACCOUNT FOR THE ISSUANCE OF STOCK Common Stock Illustration: Home Depot needs to raise $100 million through issuance of stock. Suppose Home Depot’s common stock had carried a par value equal to its issuance price of $10 per share. The entry for issuance of 10 million shares of stock at par would be Account Debit Credit Jan 8 Cash (10,000,000 x $10) 100,000,000 Common Stock To issue common stock LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Common Stock Above Par Illustration: Home Depot needs to raise $100 million through issuance of stock. Suppose Home Depot’s common stock had a par value of $0.05. The entry for issuance of 10 million shares of stock at $10 per share would be: Account Debit Credit Jan 8 Cash (10,000,000 x $10) 100,000,000 Common Stock 500,000 Paid-in Capital 99,500,000 To issue common stock Common stock = 10,000,000 × $0.05 = $500,000 LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Common Stock Above Par Illustration: Stockholders’ Equity section of The Home Depot, Inc.’s Balance Sheet might appear as follows (figures assumed): Stockholders’ Equity Common stock, $.05 par, 10 billion shares authorized, 10 million shares issued and outstanding $ ,000 Paid-in Capital 99,500,000 Total paid-in capital 100,000,000 Retained earnings 500,000,000 Total stockholders’ equity $600,000,000 LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

No-Par Common Stock Illustration: Apple, Inc., issues 939 million shares of no-par common stock for $16,422 million. Apple’s stock issuance entry is (in millions): Account Debit Credit Aug 14 Cash 16,422 Common Stock To issue no-par common stock LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

No-Par Common Stock Illustration: Apple, Inc., reports stockholders’ equity on its balance sheet as follows (in millions): Stockholders’ Equity (in millions) Common stock, no par, 1,800 shares authorized, 939 shares issued and outstanding $ 16,422 Retained earnings 101,289 Accumulated other comprehensive income 499 Total stockholders’ equity $ 118,210 LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Common Stock Issued for Assets Other Than Cash Illustration: On November 12, Kahn Corporation issued 15,000 shares of its $1 par common stock for equipment with a market value of $4,000 and a building with a market value of $120,000. Account Debit Credit Nov 12 Equipment 4,000 Building 120,000 Common Stock (15,000 x $1) 15,000 Paid-in Capital in Excess of Par--Common 109,000 ($124,000 - $15,000) To issue common stock LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Common Stock Issued for Services Illustration: Kahn Corporation engages an attorney. The attorney bills the corporation $25,000 for services and agrees to accept 2,500 shares of $1 par common stock, rather than cash, in settlement of the fee. The fair market value of the stock is $10 per share. The journal entry to record the transaction is Account Debit Credit Legal Expense 25,000 Common Stock (2,500 x $1) 2,500 Paid-in Capital in Excess of Par--Common 22,500 ($25,000 - $2,500) To issue common stock LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Preferred Stock Follows same pattern as accounting for common stock May have separate accounts for paid-in capital in excess of par for preferred and common Can be issued with conversion feature Allows preferred shareholders to exchange preferred shares for common LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Preferred Stock Illustration: Convertible preferred stock $1 par, 50,000 shares issued at par value Account Debit Credit 2014 Cash 50,000 Convertible Preferred Stock Issue convertible preferred stock LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Preferred Stock Illustration: Converted preferred stock to common stock at the rate of 6.25 to 1 (8,000 shares of $1 par-value common stock issued in exchange for 50,000 shares of preferred stock). Account Debit Credit 2014 Convertible Preferred Stock 50,000 Common Stock 8,000 Paid-in Capital in Excess of Par--Common 42,000 Convert convertible preferred stock into common stock LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Authorized, Issued, and Outstanding Stock Authorized Maximum number of shares the company can issue under its charter Issued Number of shares the company has issued to its stockholders Outstanding Number of shares that stockholders own (number of shares in the hands of stockholders) LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

SHOW HOW TREASURY STOCK AFFECTS A COMPANY Issued shares reacquired by the company Reasons: Make shares available for employee stock purchase plans Plan to “buy low” and “sell high” Avoid takeover Increase earnings per share Use in share repurchase program LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

How Is Treasury Stock Recorded? Recorded at cost Not par value Classified as a contra-stockholders’ equity account Debit balance Illustration: The following entry records the repurchase of 74 million shares for $4 billion. Account Debit Credit 2012 Treasury Stock 4,000,000,000 Cash LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

How Is Treasury Stock Recorded? The Home Depot, Inc. Stockholders’ Equity January 29, 2012 (in millions) Common stock 87 Paid-in Capital 6,966 Retained earnings 17,246 Accumulated other comprehensive income 293 Treasury stock (196,000,000 shares) (6,694) Total stockholders’ equity $ 17,898 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Retirement of Treasury Stock Cancel stock certificates Stock cannot be reissued Once shares are repurchased, neither total assets nor total liabilities are affected Memorandum entry made decreasing number of shares issued in stockholders’ equity LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Resale of Treasury Stock Increases assets and equity No gain or loss on transactions involving treasury stock Amounts received on resale in excess of amounts originally paid for treasury stock are recorded as Paid- in Capital from Treasury Stock Transaction Amounts received from resale of treasury stock less than amounts originally paid are debited to Paid-in Capital from Treasury Stock Transactions to extent of that balance, and after that, to Retained Earnings LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Resale of Treasury Stock Illustration: On July 22, 2014, Home Depot resold a million shares of treasury stock for $55 per share. Assuming that the average cost of treasury shares is $54.05, the journal entry to record the resale of treasury shares would have been as follows: 2014 Account Debit Credit Jul 22 Cash 55,000,000 Treasury Stock 54,050,000 Paid-in Capital from Treasury Stock Transactions 950,000 Sold treasury stock Cost of shares sold = 1,000,000 shares × $54.05 = $54,050,000 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Illustration Illustration: At December 31, 2014, Hartnett Corporation reported the stockholders’ equity as follows (in millions): Common stock $1.50 par value per share, 2,400 million shares issued $ 3,600 Paid-in capital in excess of par value--Common 7,200 Retained earnings 1,490 Treasury stock, at cost (85) Total stockholders’ equity $12,205 Hartnett’s 2015 transactions included Issuance of 16 million shares of common stock for $10.00 per share Purchase of 6 million shares of treasury stock for $100 million Sold 3 million of the treasury shares purchased in part b for $70 million LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Illustration Illustration: Journalize the transaction to record the issuance of 16 million shares of common stock for $10.00 per share. Account Debit Credit Cash (16 million x $10) 160,000,000 Common stock (16 million x $1.50) 24,000,000 Paid-in Capital in Excess of Par—Common 136,000,000 Advance slide in presentation mode to reveal answers LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Illustration Illustration: Journalize the transactions to record the purchase of 6 million shares of treasury stock for $100 million and the sale of 3 million of the treasury shares purchased in part b for $70 million. Account Debit Credit Treasury stock 100,000,000 Cash 70,000,000 Treasury stock (3 million x $16.67) 50,000,000 Paid-in Capital from Treasury Stock 20,000,000 Treasury stock cost per share = $100 million ÷ 6 million shares = $16.67 Advance slide in presentation mode to reveal answers LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Issuing Stock for Employee Compensation Illustration: Home Depot issued 21 million new (not treasury) shares in conjunction with an employee stock compensation plan. The entry the company made was Account Debit Credit Compensation Expense 679,000,000 Common Stock 1,000,000 Paid-in Capital 678,000,000 Record stock-based compensation LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Stockholders’ Equity on Balance Sheet The Home Depot, Inc. Stockholders’ Equity February 3, 2013 (in millions) Common stock 88 Paid-in Capital 7,948 Retained earnings 20,038 Accumulated other comprehensive income 397 Treasury stock (at cost) 270 million shares (10,694) Total stockholders’ equity $ 17,777 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Lifetime losses & dividends Lifetime losses & dividends
ACCOUNT FOR RETAINED EARNINGS, DIVIDENDS, AND SPLITS Retained Earnings Net income Less net losses Less declared dividends Accumulated over corporation’s lifetime Credit balance Lifetime earnings Lifetime losses & dividends > Debit balance Lifetime earnings Lifetime losses & dividends < LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Should the Company Declare and Pay Cash Dividends? Dividends Distribution by a corporation to its stockholders Usually based on earnings Usually take one of three forms: Cash Stock Noncash assets LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Cash Dividends Company must have both: Enough Retained Earnings to declare the dividend Enough Cash to pay the dividend Board of directors has authority to declare a dividend Company not obligated to pay dividend until declared Three relevant dates: Declaration date Date of record (no entry) Payment date LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Cash Dividends Declaration Date Illustration: On June 19, the board of directors declares a $50,000 cash dividend. The company records the dividend as follows: Account Debit Credit Jun 19 Retained Earnings 50,000 Dividends Payable Declared a cash dividend LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Cash Dividends Payment Date Illustration: On July 10, the company paid the dividend declared on June 19. The entry to record the payment is as follows: Account Debit Credit Jul 10 Dividends Payable 50,000 Cash Paid cash dividend LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Illustration Illustration: Hartnett Corporation reported stockholders’ equity as follows (in millions): Common stock $1.50 par value per share, 2,416 million shares issued $ 3,624 Paid-in capital in excess of par value--Common 7,336 Retained earnings 1,490 Treasury stock, at cost (135) Paid-in capital from treasury stock 80 Total stockholders’ equity $12,315 Journalize the transactions to record the declaration and payment of cash dividends of $32 million. LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Illustration Illustration: Journalize the transactions to record the declaration and payment of cash dividends of $32 million. Account Debit Credit Retained Earnings 32,000,000 Dividends Payable Cash Advance slide in presentation mode to reveal answers LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Dividends on Preferred Stock Paid dividends before common stockholders Stated as a percent of par value or a dollar amount per share May be cumulative Passed dividends are owed to preferred shareholders In arrears Almost debt LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Dividends on Preferred Stock Illustration: Assume that the preferred stock of Avant Garde, Inc., is cumulative. Avant Garde passed the preferred dividend of $150,000 in Before paying dividends to common in 2014, Avant Garde must first pay preferred dividends of $150,000 for both 2013 and 2014—a total of $300,000. On September 6, 2014, Avant Garde declares a $500,000 dividend. The entry to record the declaration is as follows: Account Debit Credit Sep 6 Retained Earnings 500,000 Dividends Payable, Preferred 300,000 Dividends Payable, Common 200,000 * $150,000 x 2 = $300,000 * LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Illustration Illustration: Arizona Manufacturing, Inc., reported the following at December 31, 2014 and December 31, 2015: Stockholders’ Equity Preferred stock, cumulative, $1.00 par, 6%, 90,000 shares issued $ 90,000 Common stock, $0.30 par, 9,130,000 shares issued 1,490 Arizona Manufacturing has paid all preferred dividends through 2011. Requirements 1. Compute the total amounts of dividends to both preferred and common for 2014 and 2015 if total dividends are $90,000 in and $270,000 in 2015. LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Illustration Illustration: Total dividends are $90,000 in 2014 and $270,000 in 2015. Preferred dividend = $1.00 x 6% x 90,000 shares = $5,400 Preferred Common 2014 Dividends = $90,000 Dividends in arrears (2 years x $5,400) $10,800 Current year 5,400 16,200 Remainder to common $73,800 2015 Dividends = $270,000 264,600 Advance slide in presentation mode to reveal answers LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Stock Dividends Proportional distribution of stock to shareholders Increase stock account and decrease Retained Earnings Total equity is unchanged Reasons stock dividends are distributed Continue dividends, but conserve cash Reduce market price of shares Size of stock dividend 25% or less, recorded at market value Greater than 25%, recorded at par value LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Summary of the Effects of Stock Transactions on Assets, Liabilities, and Stockholders’ Equity Exhibit 10-7 | Effects of Stock Transactions LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

USE STOCK VALUES IN DECISION MAKING Market, Redemption, Liquidation, and Book Value Stock’s market value, or market capitalization Market price multiplied by number of shares outstanding Overall market assessment of the worth of a share of common stock is reflected in the price-earnings ratio LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

Market, Redemption, Liquidation, and Book Value Redeemable preferred stock requires company to redeem stock at a set price Liquidation value is amount that a company must pay a preferred stockholder in the event the company goes out of business Book value per share is amount of common stockholders’ equity on company’s books for each share of its stock LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

ROE: Relating Profitability to Stockholder Investment DuPont Analysis provides a way to analyze various elements of profitability, as shown in the following diagram: * minus preferred dividends LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

REPORT STOCKHOLDERS’ EQUITY TRANSACTIONS Statement of Cash Flows Financing transactions that affect both cash and equity fall into three main categories: ■ Issuance of stock ■ Treasury stock ■ Dividends LO 6 Copyright ©2015 Pearson Education Inc. All rights reserved.

A Detailed Stockholders’ Equity Section Real-World Format Stockholders’ Equity Preferred stock, 8%, $10 par, 30,000 shares authorized, issued, and outstanding $ 330,000 Common stock, $1 par, 100,000 shares authorized, 60,000 shares issued, 58,600 shares outstanding 60,000 Additional paid-in capital 2,150,000 Retained earnings 1,500,000 Less treasury stock, common (1,400 shares at cost) (40,000) Accumulated other comprehensive income 200,000 Total stockholders’ equity $4,200,000 LO 6 Copyright ©2015 Pearson Education Inc. All rights reserved.

This work is protected by United States copyright law and is provided solely for the use of instructors in teaching their courses and assessing student learning. Dissemination or sale of any part of this work (including on the World Wide Web) will destroy the integrity of the work and is not permitted. The work and materials from it should never be made available to students except by instructors using the accompanying text in their classes. All recipients of this work are expected to abide by these restrictions and to honor the intended pedagogical purposes and the needs of other instructors who rely on these materials. Copyright ©2015 Pearson Education Inc. All rights reserved.

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