Equity Reporting and Analysis in Corporations

1. Chapter 11 Reporting and Analyzing Equity

2. Conceptual Learning Objectives 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

3. Analytical Learning Objectives 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

4. Procedural Learning Objectives 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

5. Ownership can be Corporate Form of Organization C 1 An entity created by law Privately Held Existence is separate from owners Has rights and privileges Publicly Held

6. 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

7. Organizing and Managing a Corporation C 1 Stockholders Board of Directors President, Vice-President, and Other Officers Employees of the Corporation

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

9. Rights of Stockholders C 1 • Vote at stockholders’ meetings • Sell stock • Purchase additional shares of stock • Receive dividends, if any • Share equally in any assets remaining after creditors are paid in a liquidation

10. Stock Certificates and Transfer C 1 Each unit of ownership is called ashare of stock. A stock certificate serves as proof that a stockholder has purchased shares. When the stock is sold, the stockholder signs atransfer endorsementon the back of the stock certificate.

11. Basics of Capital Stock C 1 Total amount of stock that a corporation’s charter authorizes it to sell.

12. Total amount of stock that has been issued or sold to stockholders. Basics of Capital Stock C 1

13. Selling (Issuing) Stock C 1  Par valueis an arbitrary amount assigned to each share of stock when it is authorized. Market priceis the amount that each share of stock will sell for in the market.

14. Classes of Stock P1 Par Value No-Par Value Stated Value

15. 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.

16. 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.

17. Issuing Par Value Stock P1

18. 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.

19. 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.

20. 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.

21. 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

22. 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.

23. 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 2007. In 2008, the Board of Directors declare and pay cash dividends of $42,000.

24. Cumulative or Noncumulative Dividend P4

25. Participating Vs. Nonparticipating Participating or Nonparticipating Dividend P4 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. Most preferred stock is nonparticipating.

26. 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

27. June 30 Stockholders Corporation Dividends Cash Dividends P2 Regular cash dividends provide a return to investors and almost always affect the stock’s market value.

28. Entries for 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.

29. 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.

30. 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.

31. 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.

32. Deficits and Cash Dividends P2 Created when a company incurs cumulative losses or pays dividends greater than total profits earned in other years.

33. 100 shares HotAir, Inc. Common Stock $1 par 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.

34. 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.

35. 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.

36. Recording a Small Stock Dividend P3 On December 31, 2008, 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, 2009. Let’s make the December 31 entry. 100,000 × 2% = 2,000 × $10 = $20,000 2,000 × $1 par = $2,000

37. P3 Before the stock dividend. After the stock dividend.

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

39. Recording a Large Stock Dividend P3 On December 31, 2008, 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

40. 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

41. 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.

42. Treasury Stock P5

43. 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. Treasury stock is shown as a reduction in total stockholders’ equity on the balance sheet.

44. Selling Treasury Stock at Cost P5 On June 30, Whitt sold 100 shares of its treasury stock for $4 per share. $8,000 ÷ 2,000 shares = $4 cost per treasury share

45. Selling Treasury Stock Above Cost P5 On July 19, Whitt, Inc. sold an additional 500 shares of its treasury stock for $8 per share.

46. Selling Treasury Stock Below Cost P5 On August 27, Whitt sold an additional 400 shares of its treasury stock for $1.50 per share.

47. Stock Options A 1 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. Market price of stock $75 per share. Option purchase price $30 per share.

48. Stock Options P5 Options are given to key employees to motivate them to: • focus on company performance, • take a long-run perspective, and • remain with the company.

49. Statement of Retained Earnings C 4 Total cumulative amount of reported net income less any net losses and dividends declared since the company started operating.

50. Restricted Retained Earnings C 4 Legal Contractual 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.