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Intermediate Financial Accounting

Intermediate Financial Accounting. Shareholders' Equity -Contributed Capital. Objectives of this Chapter. I. Basic Characteristics of a corporation II. Accounting for issuance of common stock and preferred stock: Stock subscription Package sale of stock Characteristics of preferred stock

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Intermediate Financial Accounting

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  1. Intermediate Financial Accounting Shareholders' Equity -Contributed Capital

  2. Objectives of this Chapter • I. Basic Characteristics of a corporation • II. Accounting for issuance of common stock and preferred stock: • Stock subscription • Package sale of stock • Characteristics of preferred stock • Convertible P.S, callable P.S, redeemable P.S, P.S. with stock warrants. Stockholders' Equity(1)-Contributed Capital

  3. Objectives of this Chapter (contd.) • III. Accounting for Treasury stock: • Cost method • Par value method Stockholders' Equity(1)-Contributed Capital

  4. I. Corporation • A form of business entity. • It is established as a legal entity separated from its owners. • It has all rights as a person has (i.e., can sue or be sued, can own property, sign contract) except for voting and holding public office. Stockholders' Equity(1)-Contributed Capital

  5. Types of Corporations • 1. Private corporations. • 2. Public corporations. • 3. Domestic corporations. • 4. Foreign corporations. Stockholders' Equity(1)-Contributed Capital

  6. Types of Corporations1. Private Corporations • Private corporations: privately owned including • a. nonstock companies: companies do not issue stock and do not operate for profit (i.e., universities, hospitals churches). • b. stock companies: companies issue shares of stock to stockholders and operate for profits. Stockholders' Equity(1)-Contributed Capital

  7. Types of Corporations1. Private Corporations (contd.) • Stock companies include: • (1)Publicly-traded corporations: stock is available to public on a stock exchange. • (2)Privately-held corporations: do not allow sale of stock to the general public and stock is held by a few stockholders. Stockholders' Equity(1)-Contributed Capital

  8. Types of Corporations2. Public Corporations • Public corporations: owned by governmental units such as Federal Deposit Insurance Corporation, Pension Benefit Guaranty Corporation. Stockholders' Equity(1)-Contributed Capital

  9. Types of Corporations3. Domestic Corporations • Domestic corporations: as viewed by an individual state, are those companies incorporated in that state. • If viewed by the federal government, a domestic corporation is one that is incorporated in the U.S. Stockholders' Equity(1)-Contributed Capital

  10. Types of Corporations4. Foreign Corporations • Foreign corporations: as viewed by an individual state are those operating in the state but incorporated in another state. • If viewed by federal government, a foreign corporation is one incorporated in another country. Stockholders' Equity(1)-Contributed Capital

  11. Procedures of Forming a Corporation • 1. Apply for a charter by submitting articles of incorporation to the appropriate state officials. • 2. If the application is approved, the state will issue a charter. Stockholders' Equity(1)-Contributed Capital

  12. Procedures of Forming a Corporation (contd.) • 3. A stockholders' meeting would be held at which the initial issuance of capital stock is made to the incorporators. • 4. A board of directors is elected, a set of rules regulating the operation is established, and the board appoints the executive officers. Stockholders' Equity(1)-Contributed Capital

  13. Procedures of Forming a Corporation (contd.) • 4. Ready for operations. • 5. Issuance of stock to public to raise more capital (IPO) • Note: Regardless of the number of states in which a corporation operates, it is incorporated in one state. Stockholders' Equity(1)-Contributed Capital

  14. Organization of a Corporation • a. Stockholders (owners). • b. Board of Directors (elected by stockholders) • Decide major operation principles. • Arrange major loans, authorize contract, determine the salaries of executives. • Appoint officers. Stockholders' Equity(1)-Contributed Capital

  15. Organization of a Corporation (contd.) • c. Management: Appointed by the board of directors. • Responsible for day-to-day operations and the preparations of the financial statements. Stockholders' Equity(1)-Contributed Capital

  16. Advantages of a Corporation • 1. Separated legal entity from its owners: it can buy, sell and own properties. • 2. Limited liability for stockholders. • 3. Continuous existence. • 4. Ease of transfer of ownership. Stockholders' Equity(1)-Contributed Capital

  17. Advantages of a Corporation (cont.) • 5. Ease of capital generation. • 6. Centralized authority and responsibility-- to the President, not to numerous owners. • 7. Professional management. Stockholders' Equity(1)-Contributed Capital

  18. Disadvantages of a Corporation • 1. Government regulations. • 2. Corporation taxes (double taxation). • 3. Separation of ownership and management: principal & agent conflicts. Stockholders' Equity(1)-Contributed Capital

  19. Stockholders' Equity Section of a Corporation Balance Sheet State. • Microsfot Corporation Balance Sheets (6/30) • in millions 1999 2000 Stockholders' equity: Convertible preferred stock- shares authorized 12,000; shares issued and outstanding 13 and 0 980 0 Common stock and paid-in capital -shares authorized 12,000; shares issued and outstanding 5,109 and 5,283 13,844 23,195 Stockholders' Equity(1)-Contributed Capital

  20. Stockholders' Equity Section (cont.) • Microsfot Corporation Balance Sheets (6/30) (contd.) • in millions 1999 2000 Stockholders' equity(contd.) : Retained earnings, including other comprehensive income of $1,787 and $1,527 13,614 18,713 • Total stockholders' equity 28,438 41,368 Stockholders' Equity(1)-Contributed Capital

  21. Stockholders' Equity Statements • Microsfot Corporation Stockholders' Equity Statements (year ended 6/30) • in millions 1999 2000 Convertible preferred stock Balance, beginning of year 980 980 Conversion of pref.to com. - (980) Balance, end of year 980 0 Stockholders' Equity(1)-Contributed Capital

  22. Stockholders' Equity Statements (contd.) • Microsfot Corporation Stockholders' Equity Statements (year ended 6/30) • in millions 1999 2000 Com. stock and paid-in capital Balance, beginning of year 8,025 13,844 Common stock issued 2,338 3,554 Common stock repurchased (64) (210) Structured repurch. price differ. (328) - Proceeds from sale of put warrants 766 472 Stock option income tax benefits 3,107 5,535 Balance, end of year 13,844 23,195 Stockholders' Equity(1)-Contributed Capital

  23. Stockholders' Equity Statements(contd.) • Microsfot Corporation Stockholders' Equity Statements (year ended 6/30) • in millions 1999 2000 Retained earnings Balance, beginning of years 7,622 13,614 Net income 7,785 9,421 Other comprehensive income: Net unrealized invest. gains/losses 1,052 (283) Translation adjustment 69 23 Comprehensive income 8,906 9,161 Stockholders' Equity(1)-Contributed Capital

  24. Stockholders' Equity Statements(contd.) • Microsfot Corporation Stockholders' Equity Statements (year ended 6/30) • in millions 1999 2000 Retained earnings (contd.) Comprehensive income 8,906 9,161 Preferred stock dividends (28) (13) Immaterial pooling of interests - 97 Common stock repurchased (2,631) (4,686) Balance, end of year 13,614 18,173 • Total stockholders' equity $28,438$41,368 Stockholders' Equity(1)-Contributed Capital

  25. Terminologies Related to Stockholders' Equity (contd.) • 1. Common Stock: a class of stock with rights such as: • (a)To share proportionately in profits and losses; • (b)To share proportionately in management; • Note: more than one class of shares can be authorized by the articles of incorporation and each class would have specific rights (i.e., voting, dividends, etc.) specified in the articles. Stockholders' Equity(1)-Contributed Capital

  26. Terminologies Related to Stockholders' Equity (contd.) • 1. Common Stock: a class of stock with some rights (contd.): • (c) To share proportionately in corporate assets in liquidation; • (d) To share proportionately in any new issuance of stock of the same class (the preemptive right). Stockholders' Equity(1)-Contributed Capital

  27. Terminologies Related to Stockholders' Equity (contd.) • 2. Preferred Stock: a class of stock with rights such as: • (a) Dividends (with a higher priority than that of common stock); • (b) Sharing assets in liquidation (with a higher priority than that of common stock). Stockholders' Equity(1)-Contributed Capital

  28. Terminologies Related to Stockholders' Equity (contd.) • 3. Par Value Stock: Capital stock with a nominal dollar amount printed on the stock certificate. In the past, some states designate the par value of issued stock as the legal capital. • Note: The concept of par value and legal capital has been entirely eliminated by Model Business Corporation Act. Stockholders' Equity(1)-Contributed Capital

  29. Terminologies Related to Stockholders' Equity (contd.) • 4. No-Par Stock:capital stock without a Par Value. Many states allow the board of directors to establish a stated value, in general, is the legal capital. • Note: due to the elimination of par value and legal capital concept by Model Business Corporation Act, many companies issue no-par shares these days. Stockholders' Equity(1)-Contributed Capital

  30. Terminologies Related to Stockholders' Equity (contd.) • 5. Stated Value: a nominal value assigned to no-par stock by board of directors. • 6. Additional Paid-in Capital (or Paid-in Capital in Excess of Par Value or Premium on Capital Stock): The excess of the issuance price over the par value or the stated value. Stockholders' Equity(1)-Contributed Capital

  31. Terminologies Related to Stockholders' Equity • 7. Contributed Capital: the portion of stockholders' equity contributed by investors through the issuance of stock including common stock par value, preferred stock par value and the paid-in capital in excess of the par/stated value of both stocks. • 8.Legal Capital (eliminated by Model Business Corporation Act): the amount of contributed capital not available for dividends (usually equal to the par or stated value of outstanding stock). Stockholders' Equity(1)-Contributed Capital

  32. Terminologies Related to Stockholders' Equity • This concept of par value and legal capital has been eliminated entirely by Model Business Corporation Act which is adopted by many states. • Thus, many companies issue no-par value shares now days. • However, there are companies which issued par value stock prior to the changes in the state law and continued to issue previously authorized par value shares. Stockholders' Equity(1)-Contributed Capital

  33. Terminologies Related to Stockholders' Equity (contd.) • 9. Outstanding Stock: issued stock held by investors (not being repurchased back). • 10. Treasury Stock: issued stock repurchased by the corporation and held by the corporation, not retired. • 11. Authorized Capital: the number of shares of stock that the corporation can issue as stated in its corporate Charter. Stockholders' Equity(1)-Contributed Capital

  34. Issuance for Cash II. Accounting for the Issuance of Stock • Stock issued for cash • Example 1: (Common Stock with Par) Issued 1,000 shares of $10 par common stock for $50 per share. • Journal Entry • Cash 50,000 • Common Stock 10,000 • Paid-in Capital in Excess • of Par--Common Stock 40,000 Stockholders' Equity(1)-Contributed Capital

  35. Issuance for Cash Example 2: (Preferred Stock with Par) • Issued 1,000 shares of $10 par preferred stock for $30 per share. • Journal Entry • Cash 30,000 • Preferred Stock 10,000 • Paid-in Capital in Excess • of par -- Preferred Stock 20,000 Stockholders' Equity(1)-Contributed Capital

  36. Issuance for Cash Example 3(Common Stock with Stated Value Set by the Board of Directors) • Issued 1,000 shares of no-par common stock with a stated value $1 per share. Shares are issued at $5 per share. • Journal Entry • Cash 5,000 • Common Stock 1,000 • Paid-in Capital in Excess • of Stated Value 4,000 Stockholders' Equity(1)-Contributed Capital

  37. Issuance for Cash Example 4(No-par Common Stock without Stated Value) • Issued 1,000 shares of no-par and no stated value common stock for $5 per share. • Journal Entry • Cash 5,000 • Common Stock 5,000 Stockholders' Equity(1)-Contributed Capital

  38. Stock Issuance Costs • Costs relate directly to the initial issuance of capital stock (i.e., legal fees, accountants' fees,printing costs, promotion costs, postage, expense of filing with the SEC, etc.) are recorded as reduction of the paid-in capital. • Costs relate to subsequent issuance of stock are expensed. Stockholders' Equity(1)-Contributed Capital

  39. Stock Subscriptions • Investors agree to buy stock on an "installment" ( or credit) basis. • The corporation and the prospective stockholders enter into a legal binding subscription contract when such an agreement has been made. Stockholders' Equity(1)-Contributed Capital

  40. Example • Emery enters into a subscription contract with several subscribers that calls for the purchase of 1,000 shares of $6 par common stock at a price of $13 per shares. The contract requires a $3 down payment per share, with the remaining $10 per share collectible at the end of one month. The stock will be issued to subscribers upon full payment. Stockholders' Equity(1)-Contributed Capital

  41. Example (contd.) • Journal Entry to record the subscription: • Cash 3,000 • Subscription Receivable: C.S. 10,000 • C.S. Subscribed (issuable) 6,000 • Additional Paid-in Capital on C.S. 7,000 Stockholders' Equity(1)-Contributed Capital

  42. Example (contd.) • J. E. record the subscription if stock has been issued at time of subscription: • Cash 3,000 • Note Receivable: C.S. 10,000 • Common Stock 6,000 • Additional Paid-in Capital on C.S. 7,000 Stockholders' Equity(1)-Contributed Capital

  43. Reporting of the Subscription Receivable Account: (a contra account) • Subscription Receivable: reported as a contra - stockholders' equity account due to the uncertainty involved in the collection (supported by the SEC). • Common stock subscribed and the additional paid-in capital accounts are reported in the contributed capital section of stockholders' equity. Stockholders' Equity(1)-Contributed Capital

  44. Subsequent Recording • Assume that $10 per share final payment was received from subscribers for 950 shares: • Journal Entry • 1. Cash 9,500 • Subscription Receivable:C.S 9500 • 2. C.S Subscribed 5,700 • C.S. $6 Par ($6950) 5,700 Stockholders' Equity(1)-Contributed Capital

  45. Subsequent Recording (contd.) • Assume the rest of 50 remaining shares subscribed default on the contract, the following entry will be recorded: • C.S. Subscribed ($650) 300 • Additional paid-in capital • on C.S ($750) 350 • Subscription Receivable 500 • Additional Paid-in Capital • from Subscription Default ($350) 150 Stockholders' Equity(1)-Contributed Capital

  46. Combined Sales of Stock (Lump-Sum sales) • When different classes of securities are issued in a combined sale, the proceeds are allocated based on the individual relative market values of the separate securities. • If the market value of one class of security is not known, the security with the known market values is assigned a portion of the proceeds equals to its market value. Stockholders' Equity(1)-Contributed Capital

  47. Example • A corporation issues 100 "package" of securities for $82.8 per package. Each package consists of two shares of $10 par common stock and one share of $50 par preferred stock. • If the separate market values are $16 per share for the common stock and $60 per share for the preferred stock, the following entry will be recorded: Stockholders' Equity(1)-Contributed Capital

  48. Example (contd.) • Cash 8280 • 1. C.S., 10 par 2,000 • Additional paid-in capital on C.S. 880 • 2. Preferred Stock, 50 par 5,000 • Additional Paid-in capital on P.S 400 • Aggregate M.V of both securities: • $162100 + $601100 = 9,200 • Allocation: • 1. $8,280  [(162100)/9,200] = 2,880 • 2. $8,280  [(601100)/9,200] = 5,400 • 2,880 + 5,400 = 8,280 Stockholders' Equity(1)-Contributed Capital

  49. Stock Issued for Noncash Proposition • Principle: Stock issued for service or property should be recorded either at the fair value of the stock or the fair value of the property, whichever is more clearly determinable (reliable). • In most cases, if stock is traded frequently, the fair value of stock is used. Otherwise, use the market value of the property. Stockholders' Equity(1)-Contributed Capital

  50. Example- Stock Issued for Noncash Proposition • Issued 10,000 shares of $5 par C.S. for building. The market value of the stock is $15 per share and the stock is traded frequently. • Journal Entry: • Building 150,000 • C.S. 50,000 • Additional paid-in 100,000 Stockholders' Equity(1)-Contributed Capital

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