1. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-1 11 Reporting and Analyzing Equity

2. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-2 Privately Held Publicly Held Ownership can be Characteristics of Corporations Existence is separate from owners. An entity created by law. Has rights and privileges.

3. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-3 Separate Legal Entity Separate Legal Entity Limited Liability of Stockholders Limited Liability of Stockholders Ownership Rights Are Transferable Ownership Rights Are Transferable Continuous Life Continuous Life Stockholders Are Not Corporate Agents Stockholders Are Not Corporate Agents Ease of Capital Accumulation Ease of Capital Accumulation Governmental Regulation Governmental Regulation Corporate Taxes Corporate Taxes Separate Legal Entity Separate Legal Entity Limited Liability of Stockholders Limited Liability of Stockholders Ownership Rights Are Transferable Ownership Rights Are Transferable Continuous Life Continuous Life Stockholders Are Not Corporate Agents Stockholders Are Not Corporate Agents Ease of Capital Accumulation Ease of Capital Accumulation Governmental Regulation Governmental Regulation Corporate Taxes Corporate Taxes Characteristics of Corporations

4. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-4 Exh. 11.1 Stockholders Board of Directors President, Vice-President, and Other Officers Employees of the Corporation Organizing and Managing a Corporation

5. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-5 Ultimate control Stockholders usually meet once a year Selected by a vote of the stockholders Overall responsibility for managing the company Organizing and Managing a Corporation

6. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-6  Vote at stockholders’ meetings.  Sell stock.  Purchase additional shares of stock.  Share equally with other common stockholders in any dividends.  Share equally in any assets remaining after creditors are paid in a liquidation of corporate assets.  Vote at stockholders’ meetings.  Sell stock.  Purchase additional shares of stock.  Share equally with other common stockholders in any dividends.  Share equally in any assets remaining after creditors are paid in a liquidation of corporate assets. Rights of Stockholders

7. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-7 Each unit of ownership is called a share of stock. A stock certificate serves as proof that a stockholder has purchased shares. Each unit of ownership is called a share of stock. A stock certificate serves as proof that a stockholder has purchased shares. Stock Certificates and Transfer When the stock is sold, the stockholder signs a transfer endorsement on the back of the stock certificate.

8. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-8 Basics of Capital Stock Total amount of stock that a corporation’s charter authorizes it to sell.

9. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-9 Basics of Capital Stock Total amount of stock that has been issued to stockholders.

10. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-10 Par value is an arbitrary amount assigned to each share of stock when it is authorized. Market price is the amount that each share of stock will sell for in the market. Issuing Stock

11. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-11 Par, No Par, and Stated Value Common Stock Classes of Stock

12. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-12 Par Value Stock On September 1, 2002, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share. Let’s record this transaction. Par Value Stock On September 1, 2002, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share. Let’s record this transaction. Record: The cash received. The number of shares issued × the par value per share in the Common Stock account. The remainder is assigned to Contributed Capital in Excess of Par. Record: The cash received. The number of shares issued × the par value per share in the Common Stock account. The remainder is assigned to Contributed Capital in Excess of Par. Issuing Par Value Stock

13. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-13 Issuing Par Value Stock Par Value Stock On September 1, 2002, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share. Let’s record this transaction. Par Value Stock On September 1, 2002, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share. Let’s record this transaction.

14. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-14 Issuing Par Value Stock

15. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-15 Exh. 11.3 Stockholders’ Equity

16. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-16 A separate class of stock, typically having priority over common shares in... Dividend distributions. Dividend distributions. Distribution of assets in case of liquidation. Distribution of assets in case of liquidation. A separate class of stock, typically having priority over common shares in... Dividend distributions. Dividend distributions. Distribution of assets in case of liquidation. Distribution of assets in case of liquidation. Usually has a stated dividend rate. Normally has no voting rights. Preferred Stock

17. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-17 NoncumulativeCumulative Dividends in arrears must be paid before dividends may be paid on common stock. Undeclared dividends from current and prior years do not have to be paid in future years. Cumulative or Noncumulative Dividend Most preferred stock is cumulative.

18. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-18 Example: Consider the following partial Statement of Stockholders’ Equity The Board of Directors did not declare or pay dividends in 2001. In 2002, the Board of Directors declare and pay cash dividends of $42,000. Cumulative or Noncumulative Dividend

19. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-19 PreferredCommon If Preferred Stock isNoncumulative: Year 2001No dividend paid$ -0- Year 2002 Step 1: Current preferred dividend9,000$ Step 2: Remainder to common shareholders33,000$ If Preferred Stock isCumulative: Year 2001No dividend paid$ -0- Year 2002 Step 1: Dividends in arrears9,000$ Step 2: Current preferred dividend9,000 Step 3: Remainder to common shareholders24,000$ Totals18,000$ 24,000$ Cumulative or Noncumulative Dividend

20. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-20 NonparticipatingParticipating Dividends may exceed a stated amount once common stockholders receive a dividend equal to the preferred stated rate. Dividends are limited to a maximum amount each year. The maximum is usually the stated dividend rate. Participating or Nonparticipating Dividend Most preferred stock is nonparticipating.

21. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-21 To pay a cash dividend, the corporation must have a sufficient balance in retained earnings and the cash necessary to pay the dividend. Cash Dividends

22. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-22 Regular cash dividends provide a return to investors and almost always affect the stock’s market value. Dividends Stockholders June 30 Cash Dividends Corporation

23. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-23 Three important dates Date of Declaration Record liability for dividend. Dividends Date of Record No entry required. Date of Payment Record payment of cash to stockholders. Entries for Cash Dividends

24. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-24 Date of Declaration Record liability for dividend. Dividends On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. Entries for Cash Dividends

25. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-25 On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. The date of record is February 19. No Entry Required Date of Record No entry required. Entries for Cash Dividends

26. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-26 On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. The date of record is February 19. The dividend is paid on March 19. Date of Payment Record payment of cash to stockholders. Entries for Cash Dividends

27. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-27 Created when a company incurs cumulative losses or pays dividends greater than total profits earned in other years. Deficits and Cash Dividends

28. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-28 The corporation distributes additional shares of its own stock to its stockholders without receiving any payment in return. HotAir, Inc. Common Stock 100 Shares $1 par value Stock Dividends Why a stock dividend? Can be used to keep the market price on the stock affordable. Can provide evidence of management’s confidence that the company is doing well. Why a stock dividend? Can be used to keep the market price on the stock affordable. Can provide evidence of management’s confidence that the company is doing well.

29. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-29 Small Stock Dividend Distribution is  25% of the previously outstanding shares. Capitalize retained earnings for the market value of the shares to be distributed. Small Stock Dividend Distribution is  25% of the previously outstanding shares. Capitalize retained earnings for the market value of the shares to be distributed. Large Stock Dividend Distribution is > 25% of the previously outstanding shares. Capitalize retained earnings for the minimum amount required by state law, usually par or stated value of the shares. Large Stock Dividend Distribution is > 25% of the previously outstanding shares. Capitalize retained earnings for the minimum amount required by state law, usually par or stated value of the shares. Entries for Stock Dividend

30. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-30 Here is the stockholders’ equity section of Quest’s balance sheet prior to the declaration of a stock dividend. Entries for Stock Dividend

31. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-31 On December 31, 2002, Quest declared a 2% stock dividend, when the stock was selling for $10 per share. The stock will be distributed to stockholders on January 20, 2003. Let’s make the December 31 entry. Recording a Small Stock Dividend 100,000 × 2% = 2,000 × $10 = $20,000 2,000 × $1 par = $2,000 100,000 × 2% = 2,000 × $10 = $20,000 2,000 × $1 par = $2,000

32. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-32 Before the stockdividend. After the stockdividend.

33. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-33 Router, Inc. shows the following stockholders’ equity section just prior to issuing a large stock dividend. Recording a Large Stock Dividend

34. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-34 On December 31, 2002, Router declared a 40% stock dividend, when the stock was selling for $8 per share. State law requires that large stock dividends be capitalized at par value per share. 50,000 × 40% = 20,000 shares × $1 par value = $20,000 Recording a Large Stock Dividend

35. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-35 A distribution of additional shares of stock to stockholders according to their percent ownership. Common Stock $10 par value 100 shares Old Shares New Shares Common Stock $5 par value 200 shares Stock Splits

36. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-36 Thomas, Inc. has the following stockholders’ equity section just prior to a 2-for-1 stock split. Stock Splits

37. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-37 After the 2-for-1 split the stockholders’ equity section of the balance sheet looks like this... No accounting entry is made. No accounting entry is made. Stock Splits

38. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-38 Treasury Stock

39. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-39 Corporations acquire shares of their own stock. Why would a company do that? Why would a company do that? Use the shares to acquire control of another corporation. Use the shares to acquire control of another corporation. To avoid a hostile takeover. To avoid a hostile takeover. Use the shares for employee stock options. Use the shares for employee stock options. Use the shares to acquire control of another corporation. Use the shares to acquire control of another corporation. To avoid a hostile takeover. To avoid a hostile takeover. Use the shares for employee stock options. Use the shares for employee stock options. Treasury Stock

40. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-40 On May, 8, 2002, Whitt, Inc. purchased 2,000 of its own shares of stock in the open market for $8,000. Purchasing Treasury Stock Treasury stock is shown as a reduction in total stockholders’ equity on the balance sheet. Treasury stock is shown as a reduction in total stockholders’ equity on the balance sheet.

41. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-41 On June 30, 2002, Whitt sold 100 shares of its treasury stock for $4 per share. Selling Treasury Stock at Cost $8,000 ÷ 2,000 shares = $4 cost per treasury share

42. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-42 On July 19, 2002, Whitt, Inc. sold an additional 500 shares of its treasury stock for $8 per share. Selling Treasury Stock Above Cost

43. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-43 On August 27, 2002, Whitt sold an additional 400 shares of its treasury stock for $1.50 per share. Selling Treasury Stock Below Cost

44. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-44 Net Income Reporting Income Information ContinuingOperations ExtraordinaryItems DiscontinuedSegments Change in AccountingPrinciple

45. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-45 Revenues, expenses and income generated by the company’s continuing operations. Revenues, expenses and income generated by the company’s continuing operations. Reporting Income Information ContinuingOperations Net Income

46. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-46 Income from operating the discontinued segment prior to its disposal and gain or loss on the sale of the net assets of the segment. Income from operating the discontinued segment prior to its disposal and gain or loss on the sale of the net assets of the segment. Reporting Income Information DiscontinuedSegments Net Income

47. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-47 A gain or loss that is unusual in nature and infrequent in occurrence. A gain or loss that is unusual in nature and infrequent in occurrence. Reporting Income Information ExtraordinaryItems Net Income

48. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-48 The increase or decrease in income when changing from one generally accepted accounting principle to another. The increase or decrease in income when changing from one generally accepted accounting principle to another. Reporting Income Information Change in AccountingPrinciple Net Income

49. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-49 Reporting Income Information

50. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-50 Campus, Inc. prepared the following schedule in connection with its change from double-declining balance to straight-line depreciation. Campus is subject to a 20% income tax rate Campus is subject to a 20% income tax rate Changes in Accounting Principles

51. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-51 Earnings per share is one of the most widely cited items of accounting information. Earnings Per Share Basic earnings per share = Net income - Preferred dividends Weighted-average common shares outstanding

52. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-52 Derby, Inc. reports net income of $75,000 and paid preferred dividends of $10,000 during 2002. The company started the year with 10,000 shares of common stock outstanding. Derby sold an additional 4,000 share of stock on March 31, and purchased 2,000 treasury shares on September 30, 2002. Changes in Shares Outstanding

53. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-53 EPS = $75,000 - $10,000 12,500 = $5.20 Changes in Shares Outstanding Derby, Inc. reports net income of $75,000 and paid preferred dividends of $10,000 during 2002. The company started the year with 10,000 shares of common stock outstanding. Derby sold an additional 4,000 share of stock on March 31, and purchased 2,000 treasury shares on September 30, 2002.

54. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-54 Capital structure includes dilutive securities such as: Capital structure includes dilutive securities such as: Stock options (rights to purchase common stock). Stock options (rights to purchase common stock). Preferred stock convertible into common stock. Preferred stock convertible into common stock. These items may reduce the basic earnings per share. These items may reduce the basic earnings per share. The company may be required to report basic and diluted earnings per share on the face of the income statement. Complex Capital Structure

55. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-55 The right to purchase common stock at a fixed price over a specified period of time. As the stock’s price rises above the fixed option price, the value of the option increases. Option purchase price $30 per share. Market price of stock $75 per share. Stock Options

56. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-56 Options are given to key employees to motivate them to: Options are given to key employees to motivate them to: focus on company performance, focus on company performance, take a long-run perspective, and take a long-run perspective, and remain with the company. remain with the company. Options are given to key employees to motivate them to: Options are given to key employees to motivate them to: focus on company performance, focus on company performance, take a long-run perspective, and take a long-run perspective, and remain with the company. remain with the company. Stock Options

57. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-57 Total cumulative amount of reported net income less any net losses and dividends declared since the company started operating. Retained Earnings

58. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-58 Legal Contractual Most states restrict the amount of treasury stock purchases to the amount of retained earnings. Most states restrict the amount of treasury stock purchases to the amount of retained earnings. Loan agreements can include restrictions on paying dividends below a certain amount of retained earnings. Loan agreements can include restrictions on paying dividends below a certain amount of retained earnings. Restricted Retained Earnings

59. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-59 A corporation’s directors can voluntarily limit dividends because of a special need for cash such as the purchase of new facilities. Appropriated Retained Earnings

60. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-60 Correction of material errors in past years’ financial statements. If an amount is incorrectly expensed, add amount to Retained Earnings. Prior Period Adjustments

61. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-61 Many items reported in the financial statements are based on estimates. If new information comes to light that would cause us to change our estimate, we show the impact of the change in current and future periods. What do you think bad debts should be? Changes in Accounting Estimates

62. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-62 Statement of Changes in Stockholders’ Equity

63. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-63 Annual amount of cash dividends distributed to common stockholders relative to the stock’s market price. Dividend Yield = Annual cash dividends per share Market value per share Dividend Yield

64. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-64 This ratio reveals information about the stock market’s expectations for a company’s future growth in earnings, dividends, and opportunities. Price- Earnings = Market value per share Earnings per share If earnings go up, will the market price of my stock follow? Price Earnings

65. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 11-65 Now Playing: Common Not Preferred! End of Chapter 11