1. CHAPTER 18 : Shareholders’ Equity
Learning Objectives:
LO18-1 Describe the components of shareholders’ equity and explain how they are reported in a statement of shareholders' equity.
LO18-2 Describe comprehensive income and its components.
LO18-3 Understand the corporate form of organization and the nature of stock. (SELF-STUDY)
LO18-4 Record the issuance of shares when sold for cash and noncash consideration.
LO18-5 Distinguish between accounting for retired shares and treasury shares.
LO18-6 Describe retained earnings and distinguish it from paid-in capital.
LO18-7 Explain the basis of corporate dividends, including the similarities
and differences between cash and property dividends.
LO18-8 Explain stock dividends and stock splits and we account for them.
LO18-9 Discuss the primary differences between U.S. GAAP and IFRS with respect to accounting for shareholders’ equity. (SELF-STUDY)

2. The Nature of Shareholders’ Equity
Assets – Liabilities = Shareholders’ Equity
Net Assets
Amounts invested by shareholders
Sources of Shareholders’ Equity
Amounts earned by corporation
Shareholders’ equity accounts represent the ownership interests of the shareholders in a corporation. From the balance sheet, total shareholders’ equity equals total assets minus total liabilities. Another way to think about shareholders’ equity is that it represents the portion of a corporation’s assets that have been financed by the owners as opposed to that portion that has been financed by creditors.
Corporations have two primary sources of equity: amounts invested by shareholders and amounts earned by the corporation.
Paid-in capital represents amounts that shareholders have invested by buying shares of stock from the company. The retained earnings account reports the cumulative amount of net income the corporation has earned since its organization less the cumulative amount of dividends declared since organization. This is the portion of the net income that has been reinvested in the business rather than distributed to the owners in dividends. Accumulated other comprehensive income (AOCI) includes all changes in equity except those resulting from investments by owners and distributions to owners.
Shareholders’ Equity
Other gains and losses not included in net income
Paid-in Capital
Retained Earnings
Accumulated Other Comprehensive Income

3. Financial Reporting Overview
Here is a typical shareholders’ equity section of a balance sheet. The four classifications within shareholders’ equity are paid-in capital, retained earnings, accumulated other comprehensive income, and treasury stock. The primary source of paid-in capital is the investment made by shareholders when buying preferred and common stock from the company. Common and preferred stock are reported at par value, along with additional paid-in capital for both. Retained earnings represents earned capital. Accumulated other comprehensive income is the component of comprehensive income accumulated over the current and prior periods. Treasury stock indicates that some of the shares previously sold were bought back by the corporation from shareholders.

4. Accumulated Other Comprehensive Income
Accumulated other comprehensive income includes four types of gains and losses not included in net income.
Net holding gains (losses) on investments.
Gains (losses) from and amendments to postretirement benefit plans.
Gains (losses) from foreign currency translations.
Deferred gains (losses) from derivatives.
Accumulated other comprehensive income is the total change in equity excluding only transactions with owners. Typical transactions with owners are dividends and the sale or repurchase of shares.
Comprehensive income starts with net income and adds or subtracts certain unrealized gains and losses that are not reported on the income statement. Comprehensive income includes four types of gains and losses not included in net income:
Net holding gains (losses) on investments.
Net unrecognized loss on pensions.
Gains (losses) from foreign currency translations.
Deferred gains (losses) from derivatives.

5. Accumulated Other Comprehensive Income
Comprehensive income is reported periodically as it is created and also is reported as a cumulative amount.
The accumulated amount of comprehensive income is reported as a separate item of shareholders’ equity in the balance sheet.
There are 2 options for reporting comprehensive income created during the reporting period.
As an additional section of the income statement.
As a separate statement immediately following the income statement
Comprehensive income is reported periodically as it is created and also is reported as a cumulative amount.
There are two options for reporting comprehensive income created during the reporting period.
As an additional section of the income statement.
As a separate statement immediately following the income statement.
The comprehensive income accumulated over the current and prior periods is reported as a separate component of shareholders’ equity following retained earnings.

6. The Corporate Organization (SELF STUDY)
Advantages of a corporation
Continuous existence
Easy ownership transfer
Limited liability
Easy to raise capital
Disadvantages of a corporation
Double taxation
Government regulation
The corporate form of organization has several advantages. The major advantage is the ease of raising large amounts of money because both large and small investors can participate in corporate ownership. In addition, corporate owners can transfer ownership rights very easily. Stockholders are generally free to buy and sell shares of common stock to others without permission from the corporation. Organized exchanges, such as the New York Stock Exchange, maintain markets in which shares in thousands of companies are bought and sold each business day. Stockholders’ losses are limited to the amount invested in the corporation. Corporate creditors cannot make claims on the personal assets of shareholders to satisfy corporate debt. Corporations are a separate legal entity that can enter into contracts and sue and be sued. The corporation continues in existence even when ownership changes.
Corporations also have some disadvantages. Corporations pay taxes on their earnings and then if they distribute a dividend to stockholders, the stockholders pay taxes on the dividends received. This is sometimes referred to as double taxation. Corporations are subject to many laws and regulations Large, publicly traded corporations are much more heavily regulated than smaller, closely held corporations. They are subject to the provisions of the Securities and Exchange Commission Acts of 1933 and 1934, the Sarbanes-Oxley Act of 2002, and various exchange listing requirements.

7. Types of Corporations (SELF STUDY)
Not-for-profit corporations include hospitals, charities, and government agencies such as FDIC.
Publicly-held corporations whose shares are widely owned by the general public.
There are two basic types of corporations:
 Not-for-profit corporations include hospitals, charities, and government agencies such as the Federal Deposit Insurance Corporation.
 For-profit corporations that may be either a. Publicly held corporations whose shares are widely owned by the general public, or
b. Privately held corporations whose shares are owned by only a few individuals.
Our primary focus in this chapter is on corporations formed for the purpose of generating profits.
Privately-held corporations whose shares are owned by only a few individuals.

8. Hybrid Organizations (SELF STUDY)
S Corporation
Limited liability protection of a corporation.
Maximum number of owners.
Limited liability company
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.
A corporation can elect to comply with specific tax rules and be designated an S corporation. Owners of S corporations have limited liability, but income and expenses are passed through to the owners, thereby avoiding double taxation. The number of owners of an S corporation is limited by law.
Owners of a limited liability company are not liable for the debts of the business except to the extent of their investment. All owners can be involved in the management of the company without losing their limited liability. Income and expenses are passed through to the owners so double taxation is avoided. Unlike an S corporation, there are no limits to the number of owners of a limited liability company.
A limited liability partnership is similar to a limited liability company except it doesn’t provide all of the liability protection. Owners are liable for their own actions but not entirely liable for the actions of other owners.

9. The Model Business Corporation Act (SELF STUDY)
Corporate
Charter
Nature and location of business activities.
Number and classes of shares authorized.
Articles of incorporation are filed with the state.
A corporate charter is granted by the state in which a business incorporates. The corporate charter describes the nature of the firm’s business, the number and classes of shares authorized to be issued, and the composition of the initial board of directors.
The requirements for forming a corporation are determined by the laws of the state where the business is incorporated. The articles of incorporation is the application for corporate status. Once granted a charter by the state, the corporation can issue shares of stock to investors. The stockholders of a corporation elect the members of the board of directors. In turn, the members of the board of directors hire the executive officers of the corporation. Finally, officers of the corporation empower others to hire needed employees. Employees, officers, and members of the board of directors may also be shareholders of the corporation.
Board of directors appoint officers.
State issues a corporate charter.
Board of directors elected by shareholders.
Shares of stock issued.

10. Fundamental Share Rights
Right to vote.
Preemptive right to maintain percentage ownership.
In addition to the right to buy and sell shares of stock, shareholders have the right to vote at the annual meeting of stockholders. Besides electing members of the board of directors, shareholders often vote on other issues of importance to the operations of the company. Shareholders receive dividends declared by the board of directors. In the event of liquidation, they share equally in any remaining assets after creditors are paid. Shareholders may also have the preemptive right to maintain their percentage ownership when new shares are issued.
Right to share in profits when
dividends are declared.
Right to share in distribution of assets if company is liquidated.

11. Authorized, Issued, and Outstanding Shares
Authorized shares are the maximum number of shares of capital stock that can be sold to the public.
Issued shares are authorized shares of stock that have been sold.
Unissued shares are authorized shares of stock that never have been sold.
Authorized shares are the maximum number of shares of stock that can be sold to the public. The number of authorized shares is identified in the corporation’s charter that is issued by the state of incorporation. Seldom are all of the authorized shares sold to investors, so authorized shares are either issued or unissued. Issued shares are shares of stock that have been sold to investors at some point. Unissued shares are shares of stock that have never been sold to investors.

12. Authorized, Issued, and Outstanding Shares
Treasury shares are issued shares that have been reacquired by the corporation.
Outstanding shares are issued shares that are owned by stockholders.
Authorized
Shares
Outstanding
Shares
Unissued
Shares
Issued
Shares
Issued shares can be classified as either outstanding shares or treasury shares. Outstanding shares are shares that have been issued and are currently owned by stockholders. Treasury shares are shares that have been issued to stockholders, but have since been repurchased by the corporation. When a corporation retires its reacquired shares (treasury shares), those shares assume the same status as authorized but unissued shares, just as if they had never been issued.
Treasury
Shares
Retired shares have the same status as authorized but unissued shares.
Retired
Shares

13. Capital Stock Legal capital is . . .
Par value stock
Dollar amount per share is stated in the corporate charter.
Par value has no relationship to market value.
No-par stock
Dollar amount per share is not designated in corporate charter.
Corporations can assign a stated value per share (treated as if par value).
Legal capital is . . .
The portion of shareholders’ equity that must be contributed to the firm when stock is issued.
The amount of capital, required by state law, that must remain invested in the business.
Refers to par value, stated value, or full amount paid for no- par stock.
Common stock normally has a par value, which is usually a very small amount, typically less than one dollar per share. In states that require a par value per share, the par value is also the legal capital that must remain invested in the business. Par value is an arbitrary amount assigned to each share of stock in the corporate charter, and it is not related in any manner to market value, which is the selling price of a share of stock.
In addition to par value stock, some states permit no-par value common stock while some states permit no-par, stated value common stock. In those states, the stated value is treated just like the par value.
In states that require a par value or stated value per share, the par value or stated capital is also the legal capital. Legal capital is an outdated concept that refers to the
Portion of shareholders’ equity that must be contributed to the firm when stock is issued.
Amount of capital, required by state law, that must remain invested in the business.

14. Capital Stock Preferred Stock
Common stock is the basic voting stock of the corporation. It ranks after preferred stock for dividend and liquidation distribution. Dividends are determined by the board of directors.
Dividend and liquidation preference over common stock.
Generally does not have voting rights.
Usually has a par or stated value.
May be convertible, callable, and/or redeemable.
Preferred Stock
There are two basic types of capital stock: common stock and preferred stock. Common stock is the basic voting stock of the corporation. It represents the residual claim on assets in liquidation. Dividends paid must first satisfy preferred stock agreements before any distribution can be made to common stockholders.
Preferred stock is a separate class of stock that typically has priority over common stock in dividend distributions and distribution of assets in a liquidation. It normally does not have voting rights and is often callable by the corporation at a stated value. Some preferred stock issues have an additional preference to be converted into common stock at the stockholder’s choice.

15. Preferred Stock Dividends
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.
Unpaid Dividends on Cumulative PREFERRED stocks must be paid in full before any distributions to common stock.
Dividends in arrears are not liabilities, but the per share and aggregate amounts must be disclosed.
Brief Exercise 18–5
Preferred stock usually has a stated dividend that is expressed as a percentage of its par value. Cumulative preferred stock has the right to be paid both the current and all prior periods’ unpaid dividends before any dividends are paid to common stockholders.
Noncumulative preferred stock has no rights to prior periods’ dividends if they were not declared in those prior periods. Most preferred stock is cumulative.
Preferred shares may also participate in dividends beyond the stated amount. Partially participating preferred shares have a limit on the amount of additional dividends. Fully participating preferred shares receive a pro rata share of all dividends declared based on the relative par value amounts of common and preferred shares outstanding. Most preferred stock is nonparticipating.
When the preferred stock is cumulative and the directors do not declare a dividend to preferred stockholders, the unpaid dividend is called a dividend in arrears. All dividends in arrears on cumulative preferred stock must be paid in full before any dividends can be paid to common stockholders. Dividends in arrears are not liabilities because they have not been declared. However, the per share and aggregate amounts of dividends in arrears must be disclosed.

16. Brief Exercise 18–5
MLS’s common shareholders’ will receive dividends of $18 million as a result of the 2013 distribution.
Preferred Unpaid Preferred Common Dividends
2011 $20 million* $4 million $0
million** $4 million $0
million*** $0 $18 million (remainder)
Preferred Dividend Preference = $400 Million * 6% = $24 million
* $24 - $20 = $4 million dividends in arrears.
** $24 - $20 = $4 million dividends in arrears.
*** $8 million dividends in arrears plus the $24 million current preference.

17. 10,000 shares of stock are issued for $100,000 cash.
Shares Issued for Cash
10,000 shares of stock are issued for $100,000 cash.
Cash ,000
Common stock, par value ,000
Paid-in capital – excess of par …… ,000
To record issue of common stock.
$1 Par Value
No Par Value
Cash ,000
Common stock ,000
To record issue of common stock.
When shares of par value stock are issued for cash, we debit cash for the proceeds, credit common stock for the par value of the shares issued, and credit paid-in capital in excess of par for the difference between the cash proceeds and the par value.
When shares of no-par stock are issued for cash, we debit cash and credit common stock for the proceeds.
When shares of no-par stock with a stated value are issued for cash, we debit cash for the proceeds, credit common stock for the stated value of the shares issued, and credit paid-in capital in excess of stated value for the difference between the cash proceeds and the stated value.
No Par, $1 Stated Value
Cash ,000
Common stock, stated value ,000
Paid-in capital – excess of stated value … ,000
To record issue of common stock.

18. Shares Issued for Noncash Consideration
Apply the general valuation principle by using fair value of stock given up or fair value of asset received, whichever is more clearly evident.
If market values cannot be determined, use appraised values.
When shares of stock are issued in exchange for noncash assets, we apply the general valuation principle we have seen in previous chapters. The transaction is valued at the fair value of stock issued or the fair value of asset received, whichever is more clearly evident. If the stock is actively traded on an exchange, we have an objective value to use for the transaction.
If fair values cannot be determined, then we must use appraised values.

19. More Than One Security Issued for a Single Price
Allocate the lump-sum received based on the relative fair values of the two securities.
If only one fair value is known, allocate a portion of the lump- sum received based on that fair value and allocate the remainder to the other security.
Toys Inc. issued 5,000 shares of common stock, $10 par value, and 3,000 shares of preferred stock, $5 par value, for $450,000. The market values of the common stock and preferred stock were $55 and $75, respectively.
Calculate the additional paid-in capital for each class of stock.
If more than one class of shares is issued for a single price, we must allocate the lump-sum received based on the relative fair values of the two securities.
If only one fair value is known, we allocate a portion of the lump-sum received based on that fair value and allocate the remainder to the other security.
Let’s look at an example.
Toys Inc. issued 5,000 shares of common stock, $10 par value, and 3,000 shares of preferred stock, $5 par value, for $450,000. The market values of the common stock and preferred stock were $55 and $75, respectively.
Calculate the additional paid-in capital for each class of stock.

20. More Than One Security Issued for a Single Price
First we calculate the total market values of the shares issued by multiplying the market value per share times the number of shares issued. For common stock, 5,000 shares times $55 per share equals $275,000, and for preferred stock, 3,000 shares times $75 per share equals $225,000, and the sum of these two amounts gives us a total market value of $500,000.
Next we divide the market value of each class of stock by the total market value of $500,000 to get the allocation percentages. For common stock, $275,000 divided by $500,000 equals 55 percent, and for preferred stock, $225,000 divided by $500,000 equals 45 percent.
We multiply the allocation percentages times the $450,000 received to allocate the proceeds to each class of stock. For common stock, 55 percent of $450,000 is $247,500, and for preferred stock, 45 percent of $450,000 is $202,500.
Finally, we subtract the total par value of each class of stock from the allocated amounts. For common stock, 5,000 shares times $10 par value per share equals $50,000, and for preferred stock, 3,000 shares times $5 par value per share equals $15,000. The additional paid-in capital for common stock is $247,500 minus $50,000, or $197,500. The additional paid-in capital for preferred stock is $202,500 minus $15,000, or $187,500.
Now let’s record this transaction with a journal entry.
We debit cash for the proceeds of $450,000. We credit common stock for its $50,000 par value and we credit preferred stock for its $15,000 par value. Then we credit additional paid-in capital for the two classes of stock, $197,500 for common and $187,500 for preferred.
Cash ,000
Common stock, $10 par ,000
Paid-in capital – excess of par common ……… ,500
Preferred stock, $5 par ,000
Paid-in capital – excess of par preferred ……… ,500
To record issue of common and preferred stock.

21. Share Issue Costs
Registration fees
Underwriter commissions
Printing and clerical costs
Legal and accounting fees
Promotional costs
Share issue costs reduce net proceeds from selling shares, resulting in a lower amount of additional paid-in capital.
EXERCISE 7
When a company sells its shares to the public, it incurs certain costs called share issue costs. The costs include
Registration fees.
Underwriter commissions.
Printing and clerical costs.
Legal and accounting fees.
Promotional costs.
Share issue costs reduce net proceeds from selling shares, resulting in a lower amount of additional paid-in capital.

22. Exercise 18–7
Requirement 1 ($ in millions):
Cash ($424 million – 2 million) Common stock (15 million shares at $1 par per share) Paid-in capital—excess of par (difference) 407
Requirement 2
In recording the sale of shares above, the cost of services related to the sale reduced the net proceeds from selling the shares.
Since paid-in capital—excess of par is credited for the excess of the proceeds over the par amount of the shares sold, the effect of share issue costs is to reduce the amount credited to that account.
On the other hand, the costs associated with a debt issue are recorded in a separate “debt issue costs” account and amortized to expense over the life of the debt.

23. 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.
Companies can account for the reacquired shares by retiring them or by holding them as treasury shares.
A corporation might reacquire shares of its stock for a number of reasons including
Supporting the market price.
Increasing earnings per share.
For distribution in stock option plans.
To issue as a stock dividend.
For use in mergers and acquisitions.
To thwart takeover attempts.
Regardless of the reasons for repurchasing shares of stock, companies can account for the repurchase in either of the following ways:
The shares can be formally retired, or
They can be accounted for as treasury shares.

24. 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.
Price paid is less than issue price.
5,000 shares of $2 par value stock that were issued for $20 per share are reacquired for $17 per share.
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.
Consider the following example.
First, let’s examine the case where the price paid to reacquire the shares is less than the original issue price. The company pays $17 per share to reacquire 5,000 shares of $2 par value common stock that were originally issued for $20 per share.
We record this transaction by reducing common stock with a $10,000 debit for its par value, and by reducing paid-in capital in excess of par with a debit of $90,000. We credit cash for the amount paid, 5,000 shares times $17 per share equals $85,000. Finally, we credit paid-in capital—share repurchase for $15,000, the difference between the $100,000 of proceeds from the original issuance and the $85,000 paid to reacquire the shares.
Common stock ,000
Paid-in capital – excess of par common …………… ,000
Paid-in capital – share repurchase …………… ,000
Cash ……………………………………………… ,000
To record repurchase and retirement of common stock.

25. Accounting for Retired Shares
Price paid is more than issue price.
5,000 shares of $2 par value stock that were issued for $20 per share are reacquired for $25 per share.
Common stock ,000
Paid-in capital – excess of par common ………………. 90,000
Paid-in capital – share repurchase …………………….. 25,000
Cash ……………………………………………… ,000
To record repurchase and retirement of common stock.
Now let’s examine the case where the price paid to reacquire the shares is more than the original issue price. The company pays $25 per share to reacquire 5,000 shares of $2 par value common stock that were originally issued for $20 per share.
We record this transaction by reducing common stock with a $10,000 debit for its par value, and by reducing paid-in capital in excess of par with a debit of $90,000, the same entries as in the first case. We credit cash for the amount paid, 5,000 shares times $25 per share equals $125,000. Finally, we debit paid-in capital—share repurchase for $25,000, the difference between the $100,000 of proceeds from the original issuance and the $125,000 paid to reacquire the shares. The $25,000 debit to paid-in capital—share repurchase assumes that a credit balance of at least $25,000 already exists in this account.
If the credit balance is less than $25,000, we would debit retained earnings for the amount needed.
Reduce Retained Earnings if the Paid-in capital—share repurchase account balance is insufficient.

26. Accounting for Treasury Stock
Treasury stock usually does not have:
Voting rights.
Dividend rights.
Preemptive rights.
Liquidation rights.
Treasury stock is reported as an unallocated reduction of total Shareholders’ Equity.
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.
Treasury stock has no voting or dividend rights. Dividends are not paid on treasury stock, and a corporation holding its own stock cannot vote the shares at the annual meeting. In the event of liquidation, the corporation receives no portion of the liquidated assets for the shares that it holds in the treasury. Treasury stock is not an asset. The purchase of treasury stock reduces assets by the amount paid for the purchase. It is reported in the shareholders’ equity portion of the balance sheet as a reduction from total equity.
Using the cost method, we record (debit) treasury stock for the cost to purchase it. The total cost of all shares of treasury stock held by the company is the amount reported as a reduction in stockholders’ equity.
If the treasury stock is reissued, any difference between cost and issuance price is (generally) recorded in paid-in capital—share repurchase.

27. Accounting for Treasury Stock
On 5/1/12, Photos-in-a-Second reacquired 3,000 shares of its common stock at $55 per share. On 12/3/13, Photos-in-a-Second reissued 1,000 shares of the stock at $75 per share. Which of the following would be included in the 12/3/13 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.
May 1, 2012:
Treasury stock ,000
Cash ,000
To record purchase of treasury stock.
Part I.
On May 1, 2012 Photos-in-a-Second reacquired 3,000 shares of its common stock at a cost of $55 per share. On December 3, 2013, Photos-in-a-Second reissued 1,000 shares of the stock at price of $75 per share.
Would the reissue entry on December 3, 2013, include (a) a credit to cash for $165,000; (b) a debit to treasury stock for $75,000; (c) a credit to treasury stock for $55,000; or (d) a credit to cash for $75,000?
Part II.
The correct answer is choice c. Let’s look at the entries for these two transactions to help us arrive at the correct answer to the question.
The cost of the treasury stock purchase is $165,000, calculated by multiplying 3,000 shares times $55 per share. The entry on May 1, 2012, requires a debit to treasury stock and a credit to cash for $165,000 for the cost of the purchase.
The proceeds of the sale are $75,000 calculated by multiplying 1,000 shares times $75 per share. The entry on December 3, 2013, requires a debit to cash for $75,000; a credit to treasury stock for $55,000, the cost of 1,000 shares at $55 per share; and a $20,000 credit to paid-in capital—share repurchase for the difference between the reissue price and the cost of the treasury stock.
Photos-in-a-Second would report an ending balance in its treasury stock account of $110,000 as a reduction is its shareholders’ equity. The $110,000 treasury stock balance results from the original debit entry for $165,000 less the credit entry for the sale of $55,000.
December 3, 2013:
Cash ,000
Treasury stock ,000
Paid-in capital – share repurchase … ,000
To record reissue of treasury stock.

28. Where We’re Headed
The FASB and IASB are working to establish a common standard for presenting information in the financial statements, An important part of the proposal involves the organization of elements of the balance sheet, statement of comprehensive income, and statement of cash flows into a common set of classifications.
A key feature of the new format is that each of the financial statements will include classifications by operating, investing, and financing activities (similar to the current statement of cash flows). Operating and investing activities will be included within a new category, “business” activities. Each statement also will include three additional groupings: discontinued operations, income taxes, and multi-category transactions (if needed).
The FASB and IASB are working together on a project, Financial Statement Presentation, to establish a common standard for presenting information in the financial statements, including classifying and displaying line items and aggregating line items into subtotals and totals. An important part of the proposal involves the organization of elements of the balance sheet, statement of comprehensive income, and statement of cash flows into a common set of classifications.
A key feature of the new format is that each of the financial statements will include classifications by operating, investing, and financing activities (similar to the current statement of cash flows), providing a “cohesive” financial picture that stresses the relationships among the financial statements. For each statement, though, operating and investing activities will be included within a new category, “business” activities. Each statement also will include three additional groupings: discontinued operations, income taxes, and multi-category transactions (if needed). The multi-category sections primarily encompass the acquisition and sale of other companies since they include assets and liabilities in different categories.

29. Retained Earnings
Represents the undistributed earnings of the company since its inception.
The statement of retained earnings may also contain the correction of an accounting error that occurred in the financial statements of a prior period, called a prior period adjustment.
Any restrictions on retained earnings must be disclosed in the notes to the financial statements.
Retained earnings represents the undistributed earnings of the company since its inception. The most frequent changes to retained earnings are increases due to income and decreases due to distributions to owners, primarily dividends.
The statement of retained earnings may also contain the correction of an accounting error that occurred in the financial statements of a prior period, called a prior period adjustment. Some loan agreements place restrictions on the amount of dividends that can be paid based on the balance in retained earnings. Restrictions on retained earnings are generally disclosed in the notes to the financial statements.

30. Accounting for Cash Dividends
Declared by board of directors.
Not legally
required.
Requires sufficient Retained Earnings and Cash.
Creates liability at declaration.
Declaration date
Board of directors declares a $10,000 cash dividend.
Record a liability.
Cash dividends are declared by the board of directors. There is no legal obligation to declare a cash dividend, but once declared, there is a legal obligation to pay the dividend. Most corporations that pay cash dividends pay them quarterly. To pay a cash dividend, a corporation must have two things:
 Sufficient retained earnings to absorb the dividend without going negative and
Enough cash to pay the dividend.
There are four important dates to remember when discussing dividends.
 Declaration date.
 Ex-dividend date.
 Record date.
 Payment date
The declaration date is the date the directors declare a $10,000 cash dividend. At this time a liability is created and must be recorded. The entry at the date of declaration includes a debit to retained earnings and a credit to dividends payable for $10,000.
Declaration Date:
Retained earnings ,000
Dividends payable ,000
To record declaration of cash dividend.

31. Dividend Dates Ex-dividend date Date of Record Date of Payment
The first day the shares trade without the right to receive the declared dividend. (No entry)
Date of Record
Stockholders holding shares on this date will receive the dividend. (No entry)
Date of Payment
Record the dividend payment to stockholders.
The ex-dividend date is an important date for purchasers and owners of stock. This is the date which serves as the ownership cut-off point for the receipt of the most recent declared dividend. If you buy stock after this date but before the payment date, you will not receive the dividend. A journal entry is not required on the ex-dividend date.
The date of record is important to investors because the stock must be owned on this date to receive the dividend. Although a journal entry is not required on the record date, the company prepares a list of registered owners as of this date. The persons on that list will receive the dividend.
The date of payment is the date the corporation pays the dividend to the stockholders who owned the stock on the record date. The entry on the date of payment includes a debit to dividends payable to remove the liability and a credit to cash for $10,000.
Date of Payment:
Dividends payable ,000
Cash ……………… ,000
To record payment of cash dividend.

32. Distributions of non- cash assets.
Property Dividends
Distributions of non- cash assets.
Record at fair value of noncash asset.
Recognize gain or loss for difference between book value and fair value.
Property dividends are distributions of noncash assets. The dividend is recorded at the fair value of the noncash assets distributed. A gain or loss for difference between book value and fair value of the assets distributed is recognized.

33. Accounting for Stock Dividends
Distribution of additional shares of stock to owners.
No change in total stockholders’ equity.
All stockholders retain same percentage ownership.
No change in par values.
Stock dividend < 25%
Record at current fair value of stock.
Small
Stock dividend > 25%
Record at par value of stock.
Large
A stock dividend is a distribution of additional shares of stock to stockholders. Stock dividends do not change the assets or liabilities of the business. All stockholders retain the same percentage ownership. The stockholders have more shares of stock representing the same ownership as they had before the stock dividend. There is no change in total stockholders’ equity and par value per share does not change.
Why do corporations issue stock dividends, which are merely more pieces of paper evidencing the same percentage ownership?
Corporations may issue stock dividends to
Reduce the market price per share of stock to make the shares more affordable for investors to purchase.
Signal that the management expects strong financial performance in the future.
Remind stockholders of the accounting wealth in the company, while preserving cash.
Reduce the existing balance in retained earnings.
A stock dividend can be classified as small or large. A small stock dividend is a distribution of stock that is less than 25 percent of the outstanding shares. Small stock dividends are recorded at the market value of the stock.
A large stock dividend is a distribution of stock that is equal to or greater than 25 percent of the outstanding shares. Large stock dividends are recorded at the par value of the stock.

34. Accounting for Stock Dividends
CarCo declares and distributes a 20% stock dividend on 5 million common shares. Par value is $1 and market value is $20. The required journal entry would be:
Retained earnings ,000,000
Common stock ………………………………… ,000,000
Paid-in capital – excess of par common …… ,000,000
To record declaration and distribution of small stock dividend.
CarCo declares and distributes a 20% stock dividend on 5 million common shares. Par value is $1 and market value is $20. This is a small stock dividend because it represents less than 25 percent of the outstanding shares of common stock. Because it is a small stock dividend, it will be recorded at the market value of the shares of stock issued. There are 5,000,000 shares outstanding and 20 percent of that amount means that 1,000,000 shares will be issued. Each share issued will be recorded at its market value of $20. So, the stock dividend will be valued at $20,000,000. The required journal entry would be to debit retained earnings for $20,000,000, credit common stock for $1,000,000 (1,000,000 shares issued times $1 par value per share), and credit paid-in capital in excess of par on common stock for $19,000,000 (the difference between the $20,000,000 market value and the $1,000,000 par value of the shares distributed).
5,000,000 shares × 20 % = 1,000,000 shares issued × $20 = $20,000,000

35. Stock Splits
Stock splits change the par value per share and the number of shares outstanding, but the total par value is unchanged, and no journal entry is required.
Assume that a corporation had 3,000 shares of $2 par value common stock outstanding before a 2–for–1 stock split.
Increase
Decrease
No Change
A stock split is the distribution of additional shares of stock to stockholders according to their percentage ownership. When a stock split occurs, the corporation calls in the outstanding shares and issues new shares of stock. In the process of a stock split, the par value of the stock changes, but retained earnings is unchanged. Each shareholder has the same percentage ownership of the company after the split as before the split. A journal entry is not required to record a stock split.
Let’s look at an example.
Assume that a corporation had 3,000 shares of $2 par value common stock outstanding before a two–for–one stock split. After the two-for-one split, the number of shares doubled and the par value was cut in half. Notice that an accounting entry is not required, and that retained earnings is not reduced.
In many respects a 100 percent stock dividend and a two-for-one stock split result in similar impacts to the price per share in the stock market. The stock split usually requires more administrative tasks to call in and reissue stock certificates. The practical solution is to account for the large stock distribution as a stock dividend rather than a stock split.

36. Stock Splits Effected in the Form of Large Stock Dividends
Matrix Inc. declares and distributes a 2-for-1 stock split effected in the form of a 100% stock dividend. The company has 1,000,000, $1 par value common stock outstanding. The stock is trading in the open market for $14 per share. The per share par value of the shares is not to be changed.
Most investors refer to large stock dividends as stock splits. For example a 100 percent stock dividend may be called a two-for-one stock split. Even though it is referred to as a stock split, it is accounted for as a large stock dividend, with par value remaining unchanged. Recall that large stock dividends are accounted for at par value. There are two approaches that a company might take:
 Reduce paid-in capital in excess of par to offset the credit to common stock for the par value of shares distributed.
Reduce (capitalize) retained earnings to offset the credit to common stock for the par value of shares distributed.
Let’s look at the example on your screen for the first approach.
Matrix Inc. declares and distributes a two-for-one stock split effected in the form of a 100% stock dividend. The company has 1,000,000, $1 par value common stock outstanding. The stock is trading in the open market for $14 per share. The per share par value of the shares is not to be changed. We debit paid-in capital in excess of par and credit common stock for the $1,000,000 par value of the shares distributed.
Paid-in capital – excess of par common … ,000,000
Common stock ……………..…………………… ,000,000
To record declaration and distribution of 2-for-1 stock split effected in the form of a 100% stock dividend.

37. Terminology Differences
U.S. GAAP vs. IFRS
Terminology Differences
Capital stock:
Common stock.
Preferred stock.
Paid‐in capital—excess of par, common.
Paid‐in capital—excess of par, preferred.
Share capital:
Ordinary shares.
Preference shares.
Share premium, ordinary shares.
Share premium, preference shares.
U.S. GAAP uses the term capital stock for the first category of shareholders’ equity, while IFRS uses the term share capital. Under the category capital stock, U.S. GAAP uses the terms common stock and preferred stock, while IFRS uses share capital and preference shares, respectively. Additionally, Instead of paid-in capital used by U.S. GAAP, IFRS uses the term share premium.

38. Terminology Differences
U.S. GAAP vs. IFRS
Terminology Differences
Accumulated other comprehensive income:
Net gains (losses) on investment ― AOCI.
Net gains (losses) foreign currency translation —AOCI.
Fair value adjustments not permitted.
Retained earnings.
Total shareholders’ equity.
Presented after liabilities
Reserves:
Investment revaluation reserve.
Translation reserve.
Revaluation reserve.
Retained earnings.
Total equity.
Often presented before liabilities.
IFRS uses the term reserves for the second category of shareholders’ equity. Retained earnings is included in reserves.
The term reserves is considered misleading and thus is discouraged under U.S. GAAP. Instead, U.S. GAAP uses two categories of shareholders’ equity in addition to capital stock: accumulated other comprehensive income and retained earnings.

39. Distinction between Debt and Equity for Preferred Stock
U.S. GAAP vs. IFRS
Distinction between Debt and Equity for Preferred Stock
Preferred stock normally is reported as equity, but is reported as debt with the dividends reported in the income statement as interest expense if it is “mandatorily redeemable” preferred stock.
Most non-mandatorily redeemable preferred stock (preference shares) also is reported as debt as well as some preference shares that aren’t redeemable. Under IFRS (IAS No. 32), the critical feature that distinguishes a liability is if the issuer is or can be required to deliver cash (or another financial instrument) to the holder.
Differences in the definitions and requirements can result in the same instrument being classified differently between debt and equity under IFRS and U.S. GAAP. Under U.S. GAAP, preferred stock normally is reported as equity, but is reported as debt with the dividends reported in the income statement as interest expense if it is “mandatorily redeemable” preferred stock. Under IFRS, most non-mandatorily redeemable preferred stock (preference shares) also is reported as debt as well as some preference shares that aren’t redeemable. Under IFRS (IAS No. 32), the critical feature that distinguishes a liability is if the issuer is or can be required to deliver cash (or another financial instrument) to the holder.

40. Appendix 18 ─ NOT COVERED Appendix 18: Quasi Reorganizations
A quasi reorganization allows a company undergoing financial difficulty, but with favorable future prospects, to get a fresh start by writing down inflated assets and eliminating an accumulated balance in retained earnings.
The following steps are followed in a reorganization:
The firm’s assets and liabilities are revalued to reflect market values, with corresponding debits and credits to retained earnings.
The debit balance in retained earnings (deficit) is eliminated first against additional paid-in capital, and then, if necessary, against common stock.
Retained earnings is dated to indicate when the new accumulation of earnings began.

41. End of Chapter 18
End of Chapter 18.