1. Intermediate Accounting
S t I c e | S t I c e | S k o u s e n
Equity Financing
Chapter 13
Intermediate Accounting
16E
Prepared by: Sarita Sheth | Santa Monica College
COPYRIGHT © 2007
Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

2. Learning Objectives
Identify the rights associated with ownership of common and referred stock.
Record the issuance of stock for cash, on a subscription basis, and in exchange for non-cash assets or for services.
Use both the cost and par value methods to account for stock repurchases.
Account for the issuance of stock rights and warrants.

3. Learning Objectives
Compute the compensation expense associated with the granting of employee stock options.
Determine which equity-related items should be reported in the balance sheet as liabilities.
Distinguish between stock conversions that require a reduction in retained earnings and those that do not.
List the factors that impact the Retained Earnings balance.

4. Learning Objectives
Properly record cash dividends, property dividends, and stock splits.
Explain the background of unrealized gains and losses recorded as part of accumulated other comprehensive income, and list the major types of equity reserves found in foreign balance sheets.
Prepare a statement of changes in stockholders’ equity.

5. Time Line of Issues: Owner’s Equity
XYZ Corporation
Common Stock
ISSUE preferred or common stock
PAY cash dividends
XYZ Corporation
Common Stock
INCREASE shares outstanding through stock dividends and stock splits
GRANT options to officers and employees

6. Time Line of Issues: Owners’ Equity
XYZ Corporation
Common Stock
REPURCHASE shares of stock
XYZ Corporation
Common Stock
CONVERT other securities into shares of common stock
REPORT performance to current and potential investors
XYZ Corporation

7. Nature and Classifications of Paid-In Capital
A corporation is a legal artificial entity separate from its owners.
Individuals contribute capital for which the corporation issues certificates making them stockholders.
The board of directors are elected by the stockholders and they are in charge of overseeing the long run plan for the organization.

8. Common Stock
Common Stock (CS)- when a corporation is formed, the single class of stock typically issued.
Owners of common stock have these basic rights:
To vote in the election of directors and in the determination of certain corporate policies.
Preemptive right- to maintain one’s proportional inerest in the corporation through purchase of additional common stock if and when it is issued.

9. Par or Stated Value
Par Value- historically was equal to the market value of the shares at issuance.
Today, most stocks have a nominal par value or no par value.
Stated value- stocks with no-par that for financial reporting purposes acts like a par value.

10. Preferred Stock Rights given up by preferred stockholders (PS):
Voting- in most PS are not allowed to vote for the board of directors.
Sharing in success- Cash dividends received by PS are usually fixed in amount. If the firm does extremely well, their dividend amount is not adjusted.

11. Preferred Stock Rights enjoyed by preferred stockholders:
Cash dividend preference- PS are entitled to receive their full cash dividend before any cash dividends are paid to CS.
Liquidation preference- In the even of bankruptcy, PS are entitled to have their investments repaid before CS.

12. Types of Preferred Stock
Cumulative
Has the right to receive accumulated dividends before any dividends may be paid to common stockholders.
Dividends on cumulative preferred stock that are passed are referred to as dividends in arrears.
Non-
Cumulative
Has no right to “passed”
dividends.
Participating
Has claim to a portion of
common dividends after
receiving preferred dividends.

13. Types of Preferred Stock
Convertible
Permits the holder to exchange
preferred stock for common stock.
Callable
Permits the issuing company
to redeem the preferred stock.
Redeemable
Permits the holder to redeem
The stock—usually with some
restrictions.

14. Issuance of Capital Stock
The issuance of stock for cash is recorded by a debit to Cash and a credit to Capital Stock for the par value.
When the amount of cash received for the stock is more than the par value, the excess is recorded as a credit to additional paid-in capital or paid in capital in excess of par.

15. Capital Stock Issued for Cash
Goode Corporation issued 4,000 shares of $1 par common stock on April 1, 2006, for $45,000 cash.
Apr. 1
Cash 45,000
Common Stock 4,000
Paid-In Capital in Excess of Par ,000

16. Capital Stock Issued for Cash
Goode Corporation issued 4,000 shares of no par common stock without a stated value on April 1, 2006, for $45,000 cash.
Apr. 1
Cash 45,000
Common Stock 45,000

17. Capital Stock sold on Subscription
On November 1, 2006, a firm received subscriptions for 5,000 shares of $1 par common at $12.50 per share with 50% down, balance due in 60 days
Nov. 1
CS Subscription Receivable 62,500
Common Stock Subscribed ,000
Paid-In Capital in Excess of Par ,500
Cash ,250
Common Stock
Subscription Receivable 31,250

18. Capital Stock Sold on Subscription
On December 9, received balance due on one-half of subscribers and issued stock to fully paid subscribers, 2,500 shares.
Dec. 9
Cash ,625
Common Stock
Subscription Receivable ,625
Common Stock Subscribed 2,500 Common Stock ,500

19. Capital Stock Issued for Consideration Other than Cash
AC Company issues 200 shares of $0.50 par value common stock in return for land. The company’s stock is currently selling for $50 per share.
Dec. 5
Land 10,000
Common Stock Paid-In Capital in Excess
of Par ,900

20. Capital Stock Issued for Consideration Other than Cash
Assume that the land has a readily determinable market price of $12,000, but AC Company’s common stock has no established fair market value.
Dec. 5
Land 12,000
Common Stock Paid-In Capital in Excess
of Par ,900

21. Reasons Companies Repurchase Stock
Provide shares for incentive compensation and employee savings plans.
Obtain shares needed to satisfy requests by holders of convertible securities.
Reduce the amount of equity relative to the amount of debt.
Invest excess cash temporarily.

22. Reasons Companies Repurchase Stock (cont.)
Remove some shares from the open market in order to protect against a hostile takeover.
6. Improve per-share earnings by reducing the number of shares outstanding and returning inefficiently used assets to shareholders.
7. Display confidence that the stock is currently undervalued by the market.

23. Treasury Stock
Stock issued by a corporation but subsequently reacquired by the corporation and held for possible future reissuance or retirement.
Reported as a contra-equity account, not as an asset.
Does not create a gain or loss on reacquisition, reissuance, or retirement.
May decrease Retained Earnings, but cannot increase it.

24. Issued 10,000, $1 par value shares at $15 per share
Treasury Stock
Issued 10,000, $1 par value shares at $15 per share
Cost Method
Cash 150,000
Common Stock. 10,000
Paid-In Capital in
Excess of Par ,000
Par Value Method
Cash 150,000
Common Stock. 10,000
Paid-In Capital in
Excess of Par ,000

25. Required 1,000 shares at $40 per share.
Treasury Stock
Required 1,000 shares at $40 per share.
Cost Method
Treasury Stock 40,000
Cash 40,000
Par Value Method
Treasury Stock ,000
Paid-In Capital in Excess of Par ,000
Retained Earnings ,000
Cash ,000

26. Retired remaining 300 shares of treasury stock.
Cost Method
Common Stock
Paid-in Capital in Excess of Par 4,200
Retained Earnings ,500
Treasury Stock ,000
Par Value Method
Common Stock
Treasury Stock

27. Stop and Think
After looking at this comparison on page 791 in your book, why do you think so few companies use the pare value method?

28. Stock Rights, Warrants, and Options
Stock rights- Issued to existing shareholders to permit them to maintain their proportionate ownership interests when new shares are to be issued.
Stock warrants- Sold by the corporation for cash, generally in conjunction with the issuance of another security.
Stock options- Granted to officers or employees, usually as part of a compensation plan.

29. Stock Warrants
Stewart Co. sells 1,000 shares of $50 par preferred stock for $58 per share. Stewart Co. gives the purchaser detachable warrants enabling the holders to subscribe to 1,000 shares of $2 par common stock for $25 per share. Immediately following the issuance of the stock, the warrants are selling for $3, and the fair market value of a preferred share without the warrant attached is $57.

30. Stock Warrants = $2,900 Value assigned to warrants
Total issue price
Market value of warrants x =
Market value of security without warrants
Market value of warrants +
$57 + $3
Value assigned to warrants =
$58,000 x $3
= $2,900

31. Stock Warrants
The entry on Stewart’s book to record the sale of the preferred stock with detachable warrants is:
Cash ,000
Preferred Stock, $50 par 50,000 Paid-In Capital in Excess of
Par--Preferred Stock 5,100
Common Stock Warrants 2,900

32. Stock Warrants If the warrants were exercised:
Common Stock Warrants 2,900
Cash ,000
CS, $2 par ,900
Paid-In Capital Excess of Par-CS ,900
If the warrants were allowed to expire:
Common Stock Warrants 2,900
Paid-In Capital Excess of Par-CS ,900

33. Stock Based Compensation
3333
Stock Based Compensation
Yes No
All employees eligible? No
Compensatory Plan
Shares offered equally? No
Determine compensation
expense; amortize
over period employee
is to provide service.
Reasonable exercise period?
Grant and
Measurement
dates same?
Yes
Yes No No
Exercise Prices » Market Price?
Estimate compensation
expense; amortize
over period employee
is to provide service. No
Number of shares
and Exercise Price
known?
Non-compen-
satory Plan
Yes
Record shares
issued when stock
is purchased.
Determine actual expense;
amortize over remaining
period employee is to
provide service.
Record shares issued
when stock is purchased.
Adjust for Unearned
Compensation, if any.

34. Stock Based Compensation
The company estimates a grant date value of $10 for each of the employee stock options. The total fair value of the options granted is $100,000. Compensation cost is allocated over three years from January 1, 2006 (the grant date) to January 1, 2009 (the vesting date).
Dec 31, 2006
Compensation Expense 33,333
Paid-In Capital from Stock Options ,333
$100,000 ÷ 3
Similar entries would be made in 2007 and 2008.

35. Stock Based Compensation
On 12/31, 2009, all 10,000 of the options are exercised to purchase Neff’s no-par common stock.
Cash ,000
Paid-In Capital from Stock Options 100,000
CS, no par ,000
On 12/31, 2009, if the options had been allowed to expired:
Paid-In Capital from Stock Options 600,000
Pain-In Capital from Expired Options ,000

36. Stop and Think
Assume that Neff’s managers are greedy, unscrupulous scoundrels. Which one of the following might Neff’s performance based stock options plan cause Neff’s management (the ones who are receiving the stock options) to do?

37. Stock Conversions Case 1
On December 31, 2008, 1,000 shares of preferred stock (par $50) are exchanged for 4,000 shares of common stock (par $1)
Dec 31, 2008
Preferred Stock, $50 par 50,000
Paid-In Capital in Excess of Par-
Preferred CS, $ ,000
CS, $1 par 4,000
Paid-In Capital in
Excess of Par-Common ,000

38. Stock Conversions Case 2
On December 31, 2008, 1,000 shares of preferred stock (par $50) are exchanged for 4,000 shares of common stock (par $20)
Dec 31, 2008
Preferred Stock, $50 par 50,000
Paid-In Capital in Excess of Par-
Preferred ,000
Retained Earnings 20,000
CS, $1 par 4,000

39. Factors Affecting Retained Earnings
Error corrections
Some changes in accounting principle
Net income
Quasi-reorganizations
Increases
Retained
Earnings

40. Factors Affecting Retained Earnings
Decreases
Some changes in accounting principles
Cash and stock dividends
Error corrections
Prior period adjustments
Treasury stock
Net loss
Retained
Earnings

41. Accounting for Dividends
Declaration date- The date the corporation’s board of directors formally declares a dividend will be paid.
Date of record- The date on which stockholders of record are identified as those who will receive a dividend.
Date of payment- The date when the dividend is actually distributed to stockholders.

42. Cash Dividends
ABC Corporation declares a $100,000 dividend; the following journal entries should be made:
Declaration Date
Dividends (Retained Earnings) 100,000
Dividends Payable 100,000
Payment Date
Dividends Payable 100,000
Cash 100,000

43. Property Dividends
Property dividends- a distribution to stockholders that is payable in some asset other than cash.
Bigler Corporation owns 100,000 shares in Tri-State Oil Co, carrying value $2,700,000, current market value $3,000,000, or $30 per share. There are 1,000,000 shares of Bigler stock outstanding. A dividend of 1/10 of a share of Tri-State Oil Co. is declared for each share of Bigler stock outstanding.

44. Declaration of Dividend
Property Dividends
Declaration of Dividend
Dividend (or Retained Earnings) 3,000,000
Property Dividends Payable 2,700,000
Gain on Distribution of Property
Dividend 300,000
Payment of Dividend
Property Dividends Payable 2,700,000
Investment in Tri-State Oil Co. 2,700,000

45. Stock Dividends Small Less than 20-25% of the outstanding shares.
Debit Retained Earnings for the MARKET value of the shares.
Large
Greater than 20-25% of the shares outstanding.
Debit Retained Earnings for the PAR value of the shares.

46. Stock Dividend: Example 1
Assume the following about Gean, Inc.:
Common stock ($2 par, 10,000
shares outstanding) $20,000
Additional paid-in capital $24,200
Retained earnings $12,500
Stock dividend declared 1,500 shares
Market price of stock $10/share
Because 1,500 shares represent 15% of the outstanding stock, it is a small stock dividend.
Is this a large or a small stock dividend??

47. Stock Dividend: Example 1
Declaration Date
Retained Earnings 15,000
Stock Dividends Distributable 3,000
Paid-In Capital in Excess of Par 12,000
Issuance Date
Stock Dividends Distributable 3,000
Common Stock 3,000

48. Stock Dividend: Example 2
Assume the following about Gimili, Inc.:
Common stock ($5 par, 20,000
shares outstanding) $100,000
Additional paid-in capital $100,000
Retained earnings $52,000
Stock dividend declared ,000 shares
Market price of stock $20/share
50% = Large Dividend

49. Stock Dividend: Example 2
Declaration Date
Retained Earnings 50,000
Stock Dividends Distributable 50,000
Issuance Date
Stock Dividends Distributable 50,000
Common Stock 50,000

50. Stop and Think
You are hired as an accounting consultant by a company that is considering issuing either a 20% stock dividend or a 25% stock dividend. From an accounting standpoint, which would you recommend?

51. Liquidating Dividends
Liquidating dividend- a return to stockholders of a portion of contributed capital.
Stubbs Corp declared and paid a cash dividend ($10 cash dividend) totaling $100,000 and a partial liquidating dividend for $50,000.
Declaration Date
Dividends (Retained Earnings) 100,000
Paid in Capital in Excess of Par 50,000
Dividends Payable 150,000
Payment Date
Dividends Payable 150,000
Cash 150,000

52. Unrealized Gains and Losses for Available-for-Sale Securities
Kendell had net income of $1,350. Other items that impacted net income are:
Available-for-Sale securities were not purchased with the immediate intention to resell, but are not going to be held for the long-term.
Unrealized gain (loss) on available-
for-sale securities $100
(Increase) Decrease in minimum
pension liability (60 )
Unrealized gain (loss) on derivative
instruments (20 )
Foreign currency translation
adjustment, increase (decrease) in
stockholders’ equity 300

53. Unrealized Gains and Losses for Available-for-Sale Securities
Net income $1,350
Other comprehensive income:
Unrealized gain on available-for-
sale securities 60
Increase in minimum pension liability (36 )
Unrealized loss on derivative
instruments (12 )
Foreign current transaction
adjustments
Comprehensive income $1,542

54. Disclosures Related to the Equity Section
Capital stock may be:
Authorized but unissued.
Subscribed for and held for issuance pending receipt of cash for the full amount of the subscription price.
Outstanding in the hands of stockholders.
Reacquired and held by the corporation for subsequent reissuance.
Canceled by appropriate corporate action.