Financial Accounting: Tools for Business Decision Making, 4th Ed.

1. Financial Accounting:Tools for Business Decision Making, 4th Ed. Kimmel, Weygandt, Kieso CHAPTER 11 Prepared by Ellen L. Sweatt Georgia Perimeter College and Barbara Muller Arizona State University West

2. Chapter 11 REPORTING AND ANALYZING STOCKHOLDERS’ EQUITY

3. Reporting and Analyzing Stockholders’ Equity After studying Chapter 11, you should be able to: • Identify and discuss the major characteristics of a corporation. • Record the issuance of common stock. • Explain the accounting for the purchase of treasury stock. • Differentiate preferred stock from common stock.

4. Reporting and Analyzing Stockholders’ Equity • Prepare the entries for cash dividends and understand the effect of stock dividends and stock splits. • Identify the items that affect retained earnings. • Prepare a comprehensive stockholders' equity section. • Evaluate a corporation's dividend and earnings performance from a stockholder's perspective.

5. Corporation • Created by law • Legal entity • Has most of the rights and privileges of a person • Classified by purpose and ownership • Purpose - profit or nonprofit • Ownership - publicly or privately held

6. Publicly Held Corporation... May have thousands of stockholders. Its stock is regularly traded on national securities markets. Privately Held Corporation... Usually has only a few stockholders and does not offer its stock for sale to general public.

7. 11 Characteristics of a Corporation 1 • Separate legal existence • Limited liability of stockholders • Transferable ownership rights • Ability to acquire capital • Continuous life • Corporation management • Government regulations • Additional taxes

8. Separate Legal Existence • Separate and distinct from its owners. • Acts under its own name. • May buy, own, sell property; borrow money; enter into legally binding contracts; may sue or be sued; pays its own taxes. • Owners (stockholders) cannot bind corporation unless owners are agents of the corporation.

9. Limited Liability of Stockholders • Creditors have recourse only to corporate assets to satisfy their claims. • Liability of stockholders limited to their investment in their corporation. • Creditors have no legal claim on personal assets of stockholders unless fraud has occurred. • Stockholders’ losses limited to amount of capital invested.

10. Transferable Ownership Rights • Ownership evidenced by shares of stock • Transfer of ownership among stockholders has no effect on corporation’s operating activities or assets, liabilities and total stockholders' equity. • Corporation does not participate in transfer of ownership rights after original sale.

11. Ability to Acquire Capital Limited liability of stockholders coupled with transferable ownership rights make it easy to raise capital.

12. Continuous Life • Life of corporation is stated in its charter - may be perpetual or limited to specific number of years (can be extended). • Corporation is separate legal entity, thus life not affected by withdrawal, death, or incapacity of a stockholder.

13. Corporation Management • The corporation establishes by-laws upon receipt of its charter from the state of incorporation. • Stockholders manage corporation indirectly through board of directors. • Board of directors • formulates operating policies • selects officers to execute policy and to perform daily management functions.

14. Corporate Organization Chart

16. Additional Taxes

17. Forming a Corporation • A corporation can operate in various states (must have a license from each state in which it does business) but can be incorporated in only one state.

18. Stockholder Rights • Once chartered, the corporation sells stock . • If only one class of stock - called common stock. • Ownership rights specified in the articles of incorporation or by-laws. • Proof of stock ownership is a printed or engraved form known as a stock certificate.

20. Stock Certificate Shows... • Name of the corporation • Stockholder's name • Class and special features of the stock • The number of shares owned • The signatures of duly authorized corporate officials.

22. Questions in Issuing Stock... • How many shares should be authorized for sale? • How should the stock be issued? • At what price should the shares be issued?

23. Authorized Stock... Maximum amount of stock a corporation is allowed to sell as authorized by corporate charter. Issued Stock... Number of shares of issued stock have been sold and been paid for. Outstanding Stock... Number of shares of issued stock that are being held by stockholders.

24. Corporations Can Issue Stock... • Directly to investors (typical in privately held corporations). • Indirectly through an investment banking firm (customary with publicly held corporations).

25. Par Value Stock... • Is capital stock that has been assigned a value per share in the corporate charter. • Legal capital per share must be retained in the business for the protection of corporate creditors.

26. No-Par Value Stock... • Capital stock that has not been assigned a value per share in the corporate charter. Stated Value of No-Par Stock • Amount per share assigned by the board of directors to no-par stock. Par Value and Stated Value have NO relationship to market value.

27. Stockholders’ Equity Section of a Corporation’s Balance Sheet Two Parts: • Paid-in (contributed) capital -Amount paid tocorporation by stockholders in exchange for shares of ownership. • Retained earnings (earned capital) -Earned capital held for future use in the business.

28. Review Which of the following represents the maximum number of shares a corporation can issue? • Outstanding shares • Issued shares • Authorized Shares • Treasury Shares

29. Review Which of the following represents the maximum number of shares a corporation can issue? • Outstanding shares • Issued shares • Authorized Shares • Treasury Shares

30. 11 Accounting for Common Stock Issues 2 • The issue of common stock affects only paid-in capital accounts. • When the issuance of common stock for cash is recorded, the par value of the shares is credited to common stock. • The portion of the proceeds above or below par value is recorded in a separate paid-in capital account.

31. Issuing Stock at Par Hydro-Slide, Inc., issues 1,000 shares of $1 par value of common stock at par for cash. Cash 1,000 Common Stock 1,000

32. Issuing Stock Above Par If Hydro-Slide, Inc., issues an additional 1,000 shares of the $1 par value common stock for cash at $5 per share, the entry is: Cash 5,000 Common Stock 1,000 Paid-in Capital in 4,000 Excess of Par Value

33. Hydro-Slide, Inc. Balance Sheet (partial) Stockholders' equity Paid-in capital Common stock $ 2,000 Paid-in capital in excess of par 4,000 Total paid-in capital $ 6,000 Retained earnings 27,000 Total stockholders' equity $33,000

34. Mead, Inc. Balance Sheet (partial) Stockholders' equity Paid-in capital Common stock,$5par value, 100,000 shares issued and outstanding $ 500,000 Retained Earnings 200,000 Total stockholders’ equity $ 700,000 BEFORE TREASURY STOCK TRANSACTION

35. 11 Treasury Stock... 3 Is a corporation's own stock • that has been issued • fully paid for • reacquired by the corporation • held in its treasury for future use.

36. Corporations Acquire Treasury Stock to... • Reissue shares to officers and employees under bonus and stock compensation plans. • Increase trading of company's stock in securities market in hopes of enhancing market value. • Have additional shares available for use in acquisition of other companies. • Reduce number of shares outstanding thereby increasing earnings per share. • Prevent a hostile takeover.

37. Purchase of Treasury Stock On February 1, 2007, Mead acquires 4,000 shares of its stock at $8 per share. Treasury Stock 32,000 Cash 32,000

38. Treasury Stock • The Treasury Stock account would increase by the cost of the shares purchased - $32,000. • The original paid-in capital account, Common Stock, would not be affected because the number of issued shares does not change. • Treasury stock is deducted from total paid-in capital and retained earnings in the stockholders' equity section of the balance sheet.

39. Mead, Inc. Balance Sheet (partial) Stockholders' equity Paid-in capital Common stock,$5par value, 100,000 shares issued and 96,000 outstanding $ 500,000 Retained Earnings 200,000 Total stockholders’ equity 700,000 Less: Treasury Stock 32,000 Total stockholders’ equity $ 668,000 AFTER TREASURY STOCK TRANSACTION

40. Review In the stockholders’ equity section, the cost of treasury stock is deducted from: • total paid-in capital and retained earnings • retained earnings • total stockholders’ equity • common stock in paid-in-capital

41. Review In the stockholders’ equity section, the cost of treasury stock is deducted from: • total paid-in capital and retained earnings • retained earnings • total stockholders’ equity • common stock in paid-in-capital

42. 11 Preferred Stock... 4 Capital stock that has contractual preferences over common stock in certain areas. • Dividends • Assets in the event of liquidation Preferred stockholders do not have voting rights.

43. Preferred Stock • Assume Corporation issues 10,000 shares of $10 par value preferred stock for $12 cash per share. Cash 120,000 Preferred Stock 100,000 Paid-in Capital in Excess 20,000 of Par Value--Preferred Stock (Preferred stock may have either a par value or no-par value.)

44. Dividend Preferences • Preferred stockholders have the right to share in the distribution of corporate income before common stockholders. • The first claim to dividends does not guarantee dividends.

45. Cumulative Dividend... Is a feature of preferred stock entitling the stockholder to receive current and unpaid prior-year dividends before common stockholders receive any dividends.

46. Dividends in Arrears... • Are preferred dividends that were scheduled to be declared but were not declared during a given period. • Are not a liability. No obligation exists until a dividend is declared by the board of directors. • Must be disclosed in the notes to the financial statements.

47. Dividends in Arrears Scientific-Leasing has 5,000 shares of 7%, $100 par value cumulative preferred stock outstanding. The annual dividend is $35,000 (5,000 x $7 per share). Dividends are 2 years in arrears Dividends in arrears ($35,000 x 2 years) $ 70,000 Current-year dividends 35,000 Total preferred dividends $105,000

48. Liquidation Preference Is a feature that gives preferred stockholders preference to corporate assets in the event of liquidation.

49. 11 Dividend... 5 • Is a distribution by a corporation to its stockholders on a pro rata basis. • Pro rata means that if you own 10% of the common shares, you will receive 10% of the dividend. • Dividend forms: • cash • property • script (promissory note to pay cash) • stock

50. Cash Dividend • Is a pro rata distribution of cash to stockholders. • A corporation must have 3 things to pay cash dividends: • Retained earnings • Adequate cash • Declared dividends