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Chapter 8

Stockholders’ Equity. Chapter 8. Learning Objectives. Account for the issuance of capital stock. Describe a compensatory stock option plan. Account for share appreciation rights . Describe the characteristics of preferred stock. Know the components of contributed capital .

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Chapter 8

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  1. Stockholders’ Equity Chapter 8

  2. Learning Objectives • Account for the issuance of capital stock. • Describe a compensatory stock option plan. • Account for share appreciation rights. • Describe the characteristics of preferred stock. • Know the components of contributed capital. • Understand the accounting for treasury stock. • Recognize compensation expense for a compensatory stock option plan using the fair value method. Account for a fixed compensatory stock option plan. • Account for a performance-based compensatory stock option plan.

  3. Owners’or Stockholders’Equity • Represents the owners’ residual interest in total assets after liabilities are recognized. • Difference between the assets and the liabilities of a company. • Is sometimes referred to as net assets.

  4. Formation of a Corporation • State laws dictate the incorporation process. • Articles of incorporation are filed with the state. -- Specify the purpose of the business, its location, classes and number of shares of capital stock authorized, etc. • The state issues a corporate charter. • A board of directors is selected.

  5. Classifications of Corporations • Public corporations -- Government-owned: FDIC, TVA • Private corporations -- Nonstock corporations • Nonprofit organizations that do not issue stock: churches, colleges, charities -- Stock corporations • Closed corporations: few stockholders • Open corporations: publicly traded

  6. Characteristics of Capital Stock Ownership of common stock usually entitles the holder to the . . . • Right to vote. • Right to participate in earnings through declared dividends. • Right to participate in distribution of assets at liquidation. • Right to retain percentage of ownership in the corporation when new shares are issued (preemptive right).

  7. Concepts and Definitions • Corporations are a separate legal entity. • Issues of stock are recorded in conformity with the cost principle. • Sales and repurchases of shares do not affect periodic net income. • Stockholders’equity is separated from debt of the entity.

  8. Concepts and Definitions • Categories of equity -- Contributed capital (Paid-in capital) • Capital Stock: Preferred and Common • Additional paid-in capital -- Retained earnings • Unappropriated and appropriated -- Unrealized capital • Increases or decreases in equity that donot result from stock transactions or from the retention of retained earnings.

  9. Concepts and Definitions Classification of capital stock • Authorized • Issued • Unissued • Treasury stock • Outstanding • Subscribed

  10. Authorized, Issued, and Outstanding Capital Stock Authorized Shares The maximum number of shares of capital stock that can be sold to the public is called the authorized number of shares.

  11. Authorized, Issued, and Outstanding Capital Stock Authorized Shares Issued shares are authorized shares of stock that have been sold. Unissued shares are authorized shares of stock that have never been sold.

  12. Authorized, Issued, and Outstanding Capital Stock Outstanding shares are issued shares that are owned by stockholders. Authorized Shares Outstanding Shares Unissued Shares Issued Shares Treasury shares are issued shares that have been reacquired by the corporation. Treasury Shares

  13. Corporations • Advantages -- Limited liability -- Capital accumulation -- Ease of ownership transfer • Disadvantages -- Increased taxation -- Difficulties of control -- Regulation

  14. Features of Equity Securities • Par value stock -- Designated dollar amount per share stated in the corporate charter. -- No relationship to market value. • Nopar stock -- Dollar amount per share not designated in corporate charter. -- Corporations can assign a stated valueper share (treated as if par value).

  15. Features of Equity Securities Legal capital is . . . -- That portion of stockholders’equity that must be contributed to the firm at the issuance of stock. -- The amount of capital, required by state law, that must remain invested in the business. -- Refers to par value, stated value, or full amount paid for nopar stock.

  16. Features of Equity Securities Common stock . . . -- Is the basic voting stock of the corporation. -- Ranks after preferred stock for dividend and liquidation distribution. -- Has dividend rates determined by the board of directors based on the corporation’s profitability.

  17. Features of Equity Securities Preferred stock . . . -- Has dividend and liquidation preference over common stock. -- Generally does not have voting rights. -- Usually has a par or stated value. -- May be convertible, callable, and/or redeemable.

  18. Features of Equity Securities Preferred stock dividends . . . -- Are usually stated as a percentage of the par or stated value. -- May be cumulative or noncumulative. -- May be partially participating, fully participating, or nonparticipating.

  19. Preferred StockCumulative Dividends • Provides that dividends not declared in previous years accumulate and must be paid in full when dividends are declared in later years before dividends can be paid on common stock. • Dividends in arrearsare not liabilities until declared. However, the per share and aggregate amounts must be disclosed.

  20. Preferred Stock Example Kites, Inc. has the following stock outstanding: Common, $1 par value, 100,000 shares Preferred, 3%, $100 par value, cumulative, 5,000 shares Preferred, 6%, $50 par value, noncumulative, 3,000 shares Dividends were paid every year except for the prior year. In the current year the board of directors declares dividends of $50,000. How much in dividends does each class of stock receive?

  21. Preferred Stock Example

  22. Preferred Stock Example

  23. Preferred Stock Example

  24. Preferred Stock Participating Preferences • Nonparticipating Limits the yearly dividends to the specified rate plus any arrearage for cumulative stock. • Partially participating Allows dividends above the specified rate on a pro rata basis with common stock up to a limit specified in the corporate charter.

  25. Preferred Stock Participating Preferences • Fully participating Allows dividends above the specified rate on a pro rata basis with common stock without any limits.

  26. Preferred Stock Example Kites, Inc. has the following stock outstanding: Common, $1 par value, 100,000 shares Preferred, 3%, $100 par value, noncumulative, 5,000 shares Dividends were paid every year except for the prior year. The preferred is partially participating up to 5%. In the current year the board of directors declares dividends of $60,000. How much in dividends does each class of stock receive?

  27. Preferred Stock Example

  28. Preferred Stock Example

  29. Preferred Stock Example

  30. Issuing Stock for Cash Par value stock: Cash (DEBIT) Common Stock, par value (CREDIT) Additional Paid-in Capital, Common Stock (CREDIT) In this entry, Common Stock is credited for the par value of the stock issued. The excess over par is credited to the Contributed Capital in Excess of Par account.

  31. Issuing Stock for Cash Nopar stock: Cash (DEBIT) Common Stock (CREDIT) Stated value stock: Cash (DEBIT) Common Stock, stated value (CREDIT) Additional Paid-in Capital, Common Stock (CREDIT) In this entry, Common Stock is credited for the stated value of the stock issued. The excess over stated value is credited to the Contributed Capital in Excess of Stated Value account.

  32. Stock Subscriptions A corporation 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 share. A $3 per share down payment is required, with the remaining $10 due in one month. Cash 3,000 Subscription Receivable: Common Stock 10,000 Common Stock Subscribed 6,000 Additional Paid-in Capital on Common Stock 7,000 $6 x 1,000

  33. Stock Subscriptions The $10 per share final payment was received from subscribers to 950 of the 1,000 shares. Cash 9,500 Subscription Receivable: Common Stock 9,500 Common Stock Subscribed 5,700 Common Stock, $6 par 5,700 950 x $6

  34. Stock Subscriptions When a default occurs, the accounting is determined by the relevant contract provisions, such as-- • Return to the subscriber the entire amount paid in. • Return to the subscriber the entire amount paid in, less any costs incurred to reissue the stock. • Issue to the subscriber a lesser number of shares based upon the total amount of payment received. • Require the forfeiture of all amounts paid in.

  35. Stock Subscriptions The subscriber to the 50 remaining shares defaults on the contract. The contract requires the forfeiture of all amounts paid in. Common Stock Subscribed 300 Additional Paid-in Capital on Common Stock 350 Subscription Receivable: Common Stock 500 Additional Paid-in Capital from Subscription Default 150 50 X $6 50 X $7 50 X $10

  36. Issuing Stockfor Noncash Assets • Use the current market value of the stock issued or the noncash consideration received, whichever is most reliably determinable. • If market values cannot be determined, use appraised values.

  37. Combined Sales of Stock Total proceeds must be allocated among the classes of stock issued: • Proportional method Allocate the lump-sum received among the classes of stock issued based on their relative market values. • Incremental method Allocate a portion of the lump-sum received to one security based on that security’s market value and allocate the remainder to the other security.

  38. Combined Sales of StockExample A corporation issues 100 packages of securities for $82.80 per package. Each package consists of two shares of $10 par common stock (market value, $16 per share) and one share of $50 par preferred stock (market value, $60 per share). Common Stock: $16 x 2 shares x 100 = $ 3,200 Preferred Stock: $60 x 1 share x 100 = 6,000 Total market value $9,200

  39. $3,200 $9,200 Common Stock: x $8,280 = $2,880 $6,000 $9,200 Preferred Stock: x $8,280 = 5,400 $8,280 Combined Sales of StockExample A corporation issues 100 packages of securities for $82.80 per package. Each package consists of two shares of $10 par common stock (market value, $16 per share) and one share of $50 par preferred stock (market value, $60 per share).

  40. Combined Sales of StockExample A corporation issues 100 packages of securities for $82.80 per package. Each package consists of two shares of $10 par common stock (market value, $16 per share) and one share of $50 par preferred stock (market value, $60 per share). Cash 8,280 Common Stock 2,000 Additional Paid-in Capital on Com. Stock 880 Preferred Stock, $50 par 5,000 Additional Paid-in Capital on Pref. Stock 400

  41. Stock Issue Costs Costs incurred to issue stock • Registration fees • Underwriter commissions • Attorney and accountant fees • Printing costs • Clerical costs • Promotional costs

  42. Stock Issue Costs Two methods of accounting for stock issue costs: Offset method Debit costs to Contributed Capital in Excess of Par. Deferred charge method Debit an intangible asset and amortize over a reasonable period.

  43. Stock Issuance Costs The FASB is planning to change GAAP so that all stock issuance costs are expensed as incurred.

  44. Unrealized Capital Represents an increase or decrease in stockholders’equity not arising from earnings, dividend payments, or a change in contributed capital. Examples include: • Unrealized holding gains and losses on available for sale securities. • Gains and losses resulting from translating foreign-denominated financial statements into US currency. • Guarantees of ESOP debt. • Pension liability adjustments.

  45. Any questions?

  46. Treasury Stock Repurchased shares of a corporation’s own stock The shares are retired or used to: • Issue in employee stock option programs. • Establish a market for the company’s stock. • Purchase assets. • Issue as a stock dividend. • Increase earnings per share. • Reduce ownership. • Thwart takeover attempts. • Reduce dividend payments.

  47. Treasury StockCharacteristics • Usually does not have: -- Voting rights -- Dividends rights -- Preemptive rights -- Liquidation rights • Reduces both assets and stockholders’ equity • Is classified as a contra account to stockholders’ equity

  48. Treasury StockRecording and Reporting Cost method (one-transaction concept) Par value method (dual-transaction concept)

  49. Treasury StockCost Method The purchase and subsequent sale of treasury stock are viewed as one transaction with two parts.

  50. Treasury StockCost Method • Acquisition of Treasury Stock -- Recorded at cost to acquire. Treasury Stock (DEBIT) Cash (CREDIT) • Issuance of Treasury Stock -- Treasury Stock credited for cost. -- Difference between cost and issuance price is (generally) recorded in Additional Paid-in Capital-Treasury Stock.

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