2. Shareholders’ Equity JOIN KHALID AZIZ COACHING CLASSES ICMAP STAGE 1,2,3,4,5 ICAP MODULE A,B,C,D PIPFA BBA & MBA B.COM & M.COM ACCOUNTING OF O/A LEVEL MA-ECONOMICS0322-3385752 KARACHI, PAKISTAN

3. 18-2 The Nature of Shareholders’ Equity Assets – Liabilities = Shareholders’ Equity Net Assets (Residual Interest)

4. 18-3 Sources of Shareholders’ Equity Shareholders’ Equity Paid-in Capital Retained Earnings Amounts earned by corporation Amounts invested by shareholders Other gains and losses not included in net income Accumulated Other Comprehensive Income

5. 18-4 The Corporate Organization Advantages:  Ease of raising capital.  Ease of ownership transfer.  Limited liability.  Continuous existence. Disadvantages:  Double taxation.  Government regulation. Advantages:  Ease of raising capital.  Ease of ownership transfer.  Limited liability.  Continuous existence. Disadvantages:  Double taxation.  Government regulation.

6. 18-5 Hybrid Organizations S Corporation  Limited liability protection of a corporation.  Maximum number of owners. Limited liability company  Limited liability protection of a corporation.  All owners may be involved in management without losing limited liability protection.  No limit on number of owners. Limited liability partnership  Owners are liable for their own actions but not entirely liable for actions of other partners. S Corporation  Limited liability protection of a corporation.  Maximum number of owners. Limited liability company  Limited liability protection of a corporation.  All owners may be involved in management without losing limited liability protection.  No limit on number of owners. Limited liability partnership  Owners are liable for their own actions but not entirely liable for actions of other partners. Double taxation avoided.

7. 18-6 Formation of a Corporation Number and classes of shares authorized. Composition of initial board of directors. Nature and location of business activities. Corporate Charter

8. 18-7 Formation of a Corporation Articles of incorporation are filed with the state. Board of directors elected by shareholders. Board of directors appoint officers. Shares of stock issued. State issues a corporate charter.

9. 18-8 Authorized, Issued, and Outstanding Capital Stock Authorized Shares The maximum number of shares of capital stock that can be sold to the public is called the authorized number of shares.

10. 18-9 Issued shares are authorized shares of stock that have been sold. Unissued shares are authorized shares of stock that have never been sold. Authorized Shares Authorized, Issued, and Outstanding Capital Stock

11. 18-10 Unissued Shares Treasury Shares Outstanding Shares Treasury shares are issued shares that have been reacquired by the corporation. Issued Shares Outstanding shares are issued shares that are owned by stockholders. Authorized Shares Authorized, Issued, and Outstanding Capital Stock

12. 18-11 Unissued Shares Retired Shares Outstanding Shares Retired shares assume the same status as authorized but unissued shares. Outstanding shares are issued shares that are owned by stockholders. Authorized Shares Authorized, Issued, and Outstanding Capital Stock

13. 18-12 Types of Capital Stock CommonPreferred

14. 18-13 The basic voting stock of the corporation. Ranks after preferred stock for dividend and liquidation distribution. Dividends determined by the board of directors. The basic voting stock of the corporation. Ranks after preferred stock for dividend and liquidation distribution. Dividends determined by the board of directors. Common Stock

15. 18-14 Preferred Stock Dividend preference over common stock. Generally does not have voting rights. Usually has a par or stated value. Preference over common stock in the event of liquidation.

16. 18-15 Are usually stated as a percentage of the par or stated value. May be cumulative or noncumulative. May be partially participating, fully participating, or nonparticipating. Are usually stated as a percentage of the par or stated value. May be cumulative or noncumulative. May be partially participating, fully participating, or nonparticipating. Preferred Stock Dividends

17. 18-16 Preferred Stock Dividends Cumulative Unpaid dividends must be paid before any distributions to common stock. Dividends in arrears are not liabilities, but must be disclosed.

18. 18-17 Comprehensive Income Comprehensive income includes losses and gains that traditionally have been excluded from net income. Net holding losses (gains) on investments. Deferred losses (gains) from derivatives. Postretirement plans: Losses (gains) Prior service cost. Losses (gains) from foreign currency translations.

19. 18-18 Comprehensive Income Components of comprehensive income created during the reporting period: ($ in millions) Net income $xxx Other comprehensive income: Net unrealized holding gains (losses) on investments (net of tax)† $ x Losses (gains) on postretirement benefit plans (net of tax)‡ (x) Prior service cost on postretirement benefit plans (net of tax)  x Deferred losses (gains) from derivatives (net of tax)§ x Losses (gains) from foreign currency translation (net of tax)* x xx Comprehensive income $xxx †Changes in the market value of securities available-for-sale. ‡Increases (decreases) in the postretirement benefit obligation from changing assumptions as well as plan assets earning less or more than expected (described in Chapter 17). Cost of recalculating postretirement benefits in prior years after amending a plan. (described in Chapter 17). §When a derivative designated as a cash flow hedge is adjusted to fair value, the gain or loss is deferred as a component of comprehensive income and included in earnings later, at the same time as earnings are affected by the hedged transaction (described in the Derivatives Appendix to the text). *Gains or losses from changes in foreign currency exchange rates. The amount could be an addition to or reduction in shareholders’ equity. (This item is discussed elsewhere in your accounting curriculum.)

20. 18-19 Comprehensive income (a) is reported periodically as it is created and (b) also is reported as a cumulative amount. Comprehensive Income There are 3 options for reporting comprehensive income created during the reporting period. The statement of comprehensive income can be presented: The accumulated amount of comprehensive income is reported as a separate item of SE in the balance sheet. As an expanded version of the income statement. Within the statement of shareholders’ equity. As a separate statement.

21. 18-20 SHARES SOLD FOR CASH Dow Industrial sells 100,000 of its common shares, $1 par per share, for $10 per share: ($ in 000s) Cash (100,000 shares at $10 price per share) 1,000 Common stock (100,000 shares at $1 par ) 100 Paid-in capital – excess of par (remainder) 900 The entire proceeds from the sale of nopar stock are recorded in the stock account: Cash (100,000 shares at $10 price per share) 1,000 Common stock 1,000

22. 18-21 Issuing Stock for Noncash Assets Record the transaction at fair value (of stock issued or of asset or service received, whichever is more clearly evident). If market values cannot be determined, use appraised values. Record the transaction at fair value (of stock issued or of asset or service received, whichever is more clearly evident). If market values cannot be determined, use appraised values.

23. 18-22 Issuing Stock for Noncash Assets DuMont Chemicals issues 1 million of its common shares, $1 par per share, in exchange for a custom- built factory for which no cash price is available. Today’s issue of the Wall Street Journal lists DuMont’s stock at $10 per share: ($ in millions) Property, plant, & equipment (1 million sh at $10) 10 Common stock (1 million shares at $1 par) 1 Paid-in capital – excess of par (remainder) 9 We record both the asset and the stock at the $10 million fair value.

24. 18-23 More Than One Security Issued for a Single Price  Allocate the amount received based on the relative fair values of the two securities.  If only one fair value is known, allocate a portion of the amount received based on that fair value and allocate the remainder to the other security.  Allocate the amount received based on the relative fair values of the two securities.  If only one fair value is known, allocate a portion of the amount received based on that fair value and allocate the remainder to the other security.

25. 18-24 More Than One Security Issued for a Single Price AP&P issues 4 million of its common shares, $1 par per share, and 4 million of its preferred shares, $10 par, for $100 million. Today’s issue of the Wall Street Journal lists AP&P’s common at $10 per share. There is no established market for the preferred shares: ($ in millions) Cash 100 Common stock (4 million shares x $1 par) 4 Paid-in capital – excess of par, common36 Preferred stock (4 million shares x $10 par) 40 Paid-in capital – excess of par, preferred20 4 million shares x $10 = $40 million $100 - 40 = $60 million

26. 18-25 Share Issue Costs Share issue costs reduce net proceeds from selling shares, resulting in a lower amount of additional paid-in capital.  Registration fees  Underwriter commissions  Printing and clerical costs  Legal and accounting fees  Promotional costs

27. 18-26 Share Buybacks A corporation might reacquire shares of its stock to...  Support the market price.  Increase earnings per share.  Distribute in stock option plans.  Issue as a stock dividend.  Use in mergers and acquisitions.  Thwart takeover attempts. A corporation might reacquire shares of its stock to...  Support the market price.  Increase earnings per share.  Distribute in stock option plans.  Issue as a stock dividend.  Use in mergers and acquisitions.  Thwart takeover attempts.

28. 18-27 I can account for the reacquired shares by retiring them or by holding them as treasury shares. Share Buybacks

29. 18-28 Accounting for Retired Shares When shares are formally retired, we reduce the same capital accounts that were increased when the shares were issued – common or preferred stock, and additional paid-in capital.

30. 18-29 Acquisition of Treasury Stock  Recorded at cost to acquire. Resale of Treasury Stock  Treasury Stock credited for cost.  Difference between cost and issuance price is (generally) recorded in paid-in capital – share repurchase. Acquisition of Treasury Stock  Recorded at cost to acquire. Resale of Treasury Stock  Treasury Stock credited for cost.  Difference between cost and issuance price is (generally) recorded in paid-in capital – share repurchase. Accounting for Treasury Stock

31. 18-30 COMPARISON OF SHARE RETIREMENT AND TREASURY STOCK ACCOUNTING American Semiconductor’s balance sheet included the following: Shareholders' Equity ($ in millions) Common stock, 100 million shares at $1 par $ 100 Paid-in capital – excess of par 900 Paid-in capital – share repurchase 2 Retained earnings2,000

32. 18-31 COMPARISON OF SHARE RETIREMENT AND TREASURY STOCK ACCOUNTING Reacquired 1 million of its common shares RetirementTreasury Stock Case 1: Shares repurchased at $7 per share Common stock ($1 par x 1 million sh) 1 Treasury stock (cost) 7 PIC – excess of par ($9 per sh) 9 PIC – share repurchase (difference) 3 Cash 7 Cash 7 OR Case 2: Shares repurchased at $13 per share Common stock ($1 par x 1 million sh) 1 Treasury stock (cost) 13 PIC – excess of par ($9 per sh) 9 PIC – share repurchase 2* Retained earnings (difference) 1 Cash 13 Cash 13 We reduce common stock and PIC – excess of par the same amounts they were increased when the shares were issued: Cash10 Common stock 1 PIC – excess of par 9 We credit PIC – share repurchase for the amount needed to make debits equal credits in the entry. *Because there is a $2 million credit balance.

33. 18-32 SUBSEQUENT SALE OF SHARES Sold 1 million shares after reacquiring shares at $13 per share (Case 2 in previous situation) RetirementTreasury Stock Case A: Shares sold at $14 per share Cash14Cash 14 Common stock (par) 1 Treasury stock (cost) 13 PIC – excess of par13 PIC – share repurchase 1 OR Case B: Shares sold at $10 per share Cash10Cash 10 Common stock (par) 1RE (to balance) 1 PIC – excess of par 9PIC – share repurchase 2* Treasury stock (cost) 13 *Because there is a $2 million credit balance.

34. 18-33 REPORTING SHARE BUYBACKS IN THE BALANCE SHEET Formally retiring shares restores the balances in both the Common stock account and Paid-in capital – excess of par to what those balances would have been if the shares never had been issued at all.  Any net increase in assets resulting from the sale and subsequent repurchase is reflected as Paid- in capital – share repurchase.  Any net decrease in assets resulting from the sale and subsequent repurchase is reflected as a reduction in retained earnings.

35. 18-34 REPORTING SHARE BUYBACKS IN THE BALANCE SHEET Shares Treasury Retired Stock Shareholders’ Equity ($ in millions) Paid-in capital: Common stock, 100 million shares at $1 par $ 99 $ 100 Paid-in capital – excess of par 891 900 Paid-in capital – share repurchase 2 Retained earnings1,999 2,000 Less: Treasury stock, 1 million shares (at cost) (13) Total shareholders’ equity$2,989 $2,989 When a share repurchase is viewed as treasury stock, the cost of the treasury stock is simply reported as a reduction in total shareholders’ equity.

36. 18-35 In 2009, Peridot, Inc. reacquired 3,000 shares of its common stock at $55 per share. In 2010, Peridot, Inc. reissued 1,000 shares of the stock at $75 per share. Which of the following would be included in the 2010 entry? a. Credit Cash for $165,000. b. Debit Treasury Stock for $75,000. c. Credit Treasury Stock for $55,000. d. Credit Cash for $75,000. In 2009, Peridot, Inc. reacquired 3,000 shares of its common stock at $55 per share. In 2010, Peridot, Inc. reissued 1,000 shares of the stock at $75 per share. Which of the following would be included in the 2010 entry? a. Credit Cash for $165,000. b. Debit Treasury Stock for $75,000. c. Credit Treasury Stock for $55,000. d. Credit Cash for $75,000. Accounting for Treasury Stock

37. 18-36 Accounting for Treasury Stock 2009 Treasury stock165,000 Cash165,000 2010 Cash 75,000 Treasury stock 55,000 PIC - share repurchase 20,000

38. 18-37 Retained Earnings Represents the undistributed earnings of the company since its inception.

39. 18-38 Cash Dividends Dividends must be declared by the board of directors before they can be paid. When a dividend is declared, a liability is created. A corporation is not legally required to pay dividends. Cash dividends require sufficient cash and retained earnings to cover the dividend.

40. 18-39 CASH DIVIDENDS On June 1, the board of directors of Craft Industries declares a cash dividend of $2 per share on its 100 million shares, payable to shareholders of record June 15, to be paid July 1: ($ in millions) June 1 – declaration date Retained earnings200 Cash dividends payable (100 million shares at $2/share) 200 June 13 – ex-dividend date no entry June 15 – date of record no entry July 1 – payment date Cash dividends payable 200 Cash 200

41. 18-40 Dividend Dates Ex-dividend date  The first day the shares trade without the right to receive the declared dividend. (No entry) June X

42. 18-41 Dividend Dates Date of record  Stockholders holding shares on this date will receive the dividend. (No entry) July X June X

43. 18-42 PROPERTY DIVIDENDS On October 1, the board of directors declares a property dividend of 2 million sh. of preferred stock that Craft had purchased in March as an investment (book value: $9 million; FV: $5/sh), payable to shareholders of record October 15, to be distributed November 1: October 1 – declaration date ($ in millions) Investment in Beaman Corporation preferred stock 1 Gain on appreciation of investment ($10 – $9) 1 Retained earnings (2 million shares at $5 per share) 10 Property dividends payable 10 October 15 – date of record no entry November 1 – payment date Property dividends payable 10 Investment in Beaman Corporation preferred stock 10 Before recording a property dividend, the asset first must be written up to fair market value. Then record the property dividend the same way as a cash dividend.

44. 18-43 STOCK DIVIDENDS A stock dividend is the distribution of additional shares of stock to current shareholders of the corporation. Because each shareholder receives the same percentage increase in shares, shareholders' proportional interest in (percentage ownership of) the firm remains unchanged. Craft declares and distributes a 10% common stock dividend (10 million shares) when the market value of the $1 par common stock is $12 per share: ($ in millions) Retained earnings (10 million shares at $12 per share) 120 Common stock (10 million shares at $1 par per share) 10 Paid-in capital – excess of par (remainder) 110 For a "small" stock dividend (less than 25%), the fair market value of the additional shares distributed is transferred from retained earnings to paid-in capital.

45. 18-44 STOCK SPLITS A stock distribution of 25% or higher is referred to as a stock split. A frequent reason for issuing a stock split is to reduce the market price per share (by half in a 2 for 1 split, for example). No journal entry, unless the stock distribution is referred to as a "stock split effected in the form of a stock dividend." Craft declares and distributes a 2 for 1 stock split effected in the form of a 100% stock dividend (100 million shares) when the market value of the $1 par common stock is $12 per share: ($ in millions) Paid-in capital – excess of par100 Common stock (100 million shares at $1 par) 100 Some companies choose to debit retained earnings instead.

46. 18-45