Chapter 11

1. Chapter 11 Corporate Reporting and Analysis

2. Conceptual Learning ObjectivesSELF-STUDY C1: Identify characteristics of corporations and their organization. C2: Describe the components of stockholders’ equity. C3: Explain characteristics of common and preferred stock. C4: Explain the items reported in retained earnings. 11-2

3. Analytical Learning ObjectivesSELF-STUDY A1: Compute earnings per share and describe its use. A2: Compute price-earnings ratio and describe its use in analysis. A3: Compute dividend yield and explain its use in analysis. A4: Compute book value and explain its use in analysis. 11-3

4. Procedural Learning ObjectivesIn-class; In-depth P1: Record the issuance of corporate stock. P2: Record transactions involving cash dividends. P3: Account for stock dividends and stock splits. P4: Distribute dividends between common stock and preferred stock. P5: Record purchases and sales of treasury stock and the retirement of stock. 11-4

5. Characteristics of Corporations C 1 Advantages • Separate legal entity • Limited liability of stockholders • Transferable ownership rights • Continuous life • Lack of mutual agency for stockholders • Ease of capital accumulation Disadvantages • Governmental regulation • Corporate taxation 11-5

6. Characteristics of Corporations Advantages: 1. Separate legal entity —a corporation, through its agents (officers and managers), may conduct business affairs with the same rights, duties, and responsibilities of a person. 2. Limited liability of stockholders —generally limited to investment. 3. Transferable ownership rights —through stock sale. 4. Continuous life -perpetual life as long as it continues to be successful. 5. Lack of mutual agency for stockholders —they do not have the power to bind the corporation to contracts. 6. Ease of capital accumulation —the corporate form enables a corporation to accumulate large amounts of capital from the combined investments of many stockholders.

7. Characteristics of Corporations • Disadvantages: • Governmental regulation —must meet requirements of a state’s incorporation laws. • 2. Corporate taxation —corporate income is taxed; and when income is distributed to shareholders as dividends, it is taxed a second time as personal income (double taxation).

8. Stockholders usually meet once a year. Ultimate control. Selected by a vote of the stockholders. Overall responsibility for managing the company. Organizing and Managing a Corporation C 1 11-8

9. Corporate Organization and Management Management of a corporation a. Stockholders have ultimate control through vote to elect board of directors. b. Board of directors has final managing authority, but it usually limits its actions to establishing broad policy. c. Day-to-day direction of corporate business is delegated to executive officers appointed by the board.

10. Corporate Organization and Management Incorporation —a charter application must be filed with the state. Upon payment of fees and issuance of the charter the corporation is formed. Organizational expenses -are the costs to organize a corporation (such as legal fees, promoters’ fees, and amounts paid to obtain a charter); these costs are expensed as incurred because it is difficult to determine the amount and timing of future benefits.

11. Stockholders of Corporations 1. Rights of stockholders Specific rights are granted by the charter and general rights by state laws. 2. Common stockholders rights include right to: a. Vote at stockholders’ meeting. b. Sell or otherwise dispose of their stock. c. Purchase their proportional shares of any common stock later issued; this preemptive right protects stockholders’ proportionate interest in the corporation. d. Share with other common stockholders in any dividends. e. Share equally in any assets remaining after creditors and preferred stockholders are paid when, and if, the corporation is liquidated. f. Receive timely financial reports.

12. Stockholders of Corporations 3. Stock certificates and transfer: A stock certificate is sometimes received as proof of share ownership. 4. Registrar and transfer agents:IF stock is traded on a major exchange, the corporation must have: a. Registrar who keeps stockholder records and prepares official lists of stockholders for stockholders’ meetings and dividend payments. b. Transfer agent who assists purchases and sales of shares by receiving and issuing certificates as necessary.

13. Basics of Capital Stock Capital stock refers to any shares issued to obtain capital (owner financing). 1. Authorized stock —the total amount of stock that the charter authorizes for sale. a. Issued stock refers to stocks issued and held by stockholders or in corporate treasury. b. Outstanding stock refers to issued stock held by stockholders. c. No formal journal entry is required for stock authorization; the number of shares authorized is disclosed in the financial statements.

14. Basics of Capital Stock C 2 Total amount of stock that a corporation’s charter authorizes it to sell. Total amount of stock that has been issued or sold to stockholders. 11-14

15. Basics of Capital Stock 2. Selling (issuing) stock—can be sold directly or indirectly to stockholders a. To sell directly, the corporation advertises its stock issuance to potential buyers. b. To sell indirectly, a corporation pays a brokerage house (investment banker) to issue its stock. c. A brokerage house may underwrite issuance (buy the stock from the corporation and take all gains or losses from its resale).

16. Basics of Capital Stock 3. Market value per share:The price at which a stock is bought or sold. a. Price is Influenced by expected future earnings, dividends, growth, and other company and economic events. 2 b. Current market value of previously issued shares does not impact that corporation’s stockholders’ equity accounts. 4. Classes of stock: a. Common —stock is called common stock when all classes have same rights and privileges. b. Additional classes —corporation is sometimes authorized to issue more than one class of stock.

17. Classes of Stock C1 Par Value No-Par Value Stated Value 11-17

18. Basics of Capital Stock 5. Par value stock —assigned a value per share by the corporation in its charter. a. Printed on the stock certificate. b. Establishes the minimum legal capital. 6. No-par value stock —not assigned a value per share by the corporate charter. *Stated value stock —no-par stock that is assigned a “stated” value per share by the directors; becomes the minimum legal capital per share.

19. Issuing Par Value Stock P1 Par Value Stock On September 1, 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 theCommon Stockaccount. • The remainder is assigned toPaid-In Capital in Excess of Par Value, Common Stock. 11-19

20. Issuing Par Value Stock P1 Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share. Let’s record this transaction. 11-20

21. Issuing Par Value Stock P1 11-21

22. Exercise 3 (Part 3 & 4)

23. Issuing Stock for Noncash Assets P1 Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for land valued at $2,500,000. Let’s record this transaction. • Record: • The asset received at its market value. • The number of shares issued × the par value per share in theCommon Stockaccount. • The remainder is assigned toPaid-In Capital in Excess of Par, Common Stock. 11-23

24. Issuing Stock for Noncash Assets P1 Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for land valued at $2,500,000. Let’s record this transaction. 11-24

25. Exercise 4

26. Issuing Stock for Organizational Expenses Organizational expenses -are the costs to organize a corporation (such as legal fees, promoters’ fees, and amounts paid to obtain a charter); these costs are expensed as incurred because it is difficult to determine the amount and timing of future benefits. A corporation may decide to pay for these Organizational Expenses by issuing stocks. Exercise 3 (Part 2 and 1)

27. Preferred Stock C 3 A separate class of stock, typically having priority over common shares in . . . • Dividend distributions • Distribution of assets in case of liquidation Usually has a stated dividend rate Normally has no voting rights 11-27

28. Reasons for Issuing Preferred Stock P4 • To raise capital without sacrificing control • To boost the return earned by common stockholders through financial leverage • To appeal to investors who may believe the common stock is too risky or that the expected return on common stock is too low 11-28

29. Types of Preferred Stocks 1. Cumulative or Non-cumulative 2. Participating or Non-participating 3. Callable and Convertible

30. Cumulative Vs. Noncumulative Cumulative or Noncumulative Dividend P4 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. Most preferred stock is cumulative. 11-30

31. Cumulative or Noncumulative Dividend P4 Example: Consider the following Stockholders’ Equity Section of the Balance Sheet The Board of Directors did not declare or pay dividends in 2009. In 2010, the Board of Directors declare and pay cash dividends of $42,000. 11-31

32. Cumulative or Noncumulative Dividend P4 11-32

33. Exercise 8 Exercise 9

34. Cash Dividends P2 To pay a cash dividend the corporation must have: • A sufficient balance in retained earnings and • The cash necessary to pay the dividend. 11-34

35. Cash Dividends P2 Three important dates Dividends Date of Declaration Date of Record Date of Payment Record liability for dividend. No entry required. Record payment of cash to stockholders. 11-35

36. Entries for Cash Dividends P2 On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. The dividend will be paid on March 19 to stockholders of record on February 19. Dividends Date of Declaration Record liability for dividend. 11-36

37. Entries for Cash Dividends P2 On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. The dividend will be paid on March 19 to stockholders of record on February 19. No entry required on February 19. Date of Record No entry required. 11-37

38. Entries for Cash Dividends C 1 On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. The dividend will be paid on March 19 to stockholders of record on February 19. Date of Payment Record payment of cash to stockholders. 11-38

39. Stock Dividends P3 The corporation distributes additional shares of its own stock to its stockholders without receiving any payment in return. • 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. 11-39

40. Small Stock Dividend Distribution is £ 25% of the previously outstanding shares. Capitalize retained earnings for the market value of the shares to be distributed. Stock Dividends P3 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. 11-40

41. Recording a Small Stock Dividend P3 Here is the stockholders’ equity section of Quest’s balance sheet prior to the declaration of asmall stock dividend. 11-41

42. Recording a Small Stock Dividend P3 On December 31, 2009, 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, 2010. Let’s make the December 31 entry. 100,000 × 2% = 2,000 × $10 = $20,000 2,000 × $1 par = $2,000 11-42

43. P3 Before the stock dividend. After the stock dividend. 11-43

44. Recording a Large Stock Dividend P3 Router, Inc. shows the following stockholders’ equity section just prior to issuing alargestock dividend. 11-44

45. Recording a Large Stock Dividend P3 On December 31, 2009, 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 11-45

46. Exercise 7

47. New Shares Stock Splits P3 A distribution of additional shares of stock to stockholders according to their percent ownership. $10 par value Old Shares Common Stock 100 shares $5 par value Common Stock 200 shares 11-47

48. Stock Splits P3 After the 2-for-1 split the stockholders’ equity section of the balance sheet looks like this . No accounting entry is made. 11-48

49. Exercise 6

50. Purchasing Treasury Stock P5 On May 8, Whitt, Inc. purchased 2,000 of its own shares of stock in the open market for $8,000. => $4 / share Treasury stock is shown as a reduction in total stockholders’ equity on the balance sheet. 11-50