Chap011

Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin

Stockholders’ Equity:Stockholders’ Equity:Paid-In CapitalPaid-In Capital

Chapter 11

11-2

Existence is separate from

owners.

Existence is separate from

owners.

An entity created by law.

An entity created by law.

Has rights and privileges.

Has rights and privileges.

Privately, or Closely Held

Publicly Held

Ownership can be

Ownership can be

CorporationsCorporations

11-3

Limited personal liability for

stockholders

Limited personal liability for

stockholders

Transferability of ownership

Transferability of ownership

Professional managementProfessional management

Continuity of existence

Continuity of existence

Advantages of Advantages of IncorporationIncorporation

11-4

Heavy taxationHeavy taxation

Greater regulationGreater regulation

Cost of formationCost of formation

Separation of ownership and management

Separation of ownership and management

Disadvantages of Disadvantages of IncorporationIncorporation

11-5

The costs associated with incorporation are usually

expensed immediately, but amortized over 5 years for

tax purposes.

The costs associated with incorporation are usually

expensed immediately, but amortized over 5 years for

tax purposes.

Formation of a CorporationFormation of a Corporation

• Each corporation is formed according to the laws of the state where it is located.

• The application for corporate status is called the Articles of Incorporation.

11-6

Stockholders

Rights

Voting (in person or by proxy).

Proportionate distribution of

dividends.

Proportionate distribution of

assets in a liquidation.

Rights of StockholdersRights of Stockholders

11-7

C orpora te O rgan iza tion C hart

Secretary Treasurer C ontro ller O ther V icePresidents

President

B oard of D irectors

StockholdersUltimate control

Ultimate control

Rights of StockholdersRights of Stockholders

Stockholders usually meet once a year.

Stockholders usually meet once a year.

11-8

C orpora te O rgan iza tion C hart

Secretary Treasurer C ontro ller O ther V icePresidents

President

B oard of D irectors

StockholdersChief

AccountantChief

Accountant

Contractual and legal representation

Contractual and legal representation

Custodian of funds

Custodian of funds

Functions of the Corporate Functions of the Corporate OfficersOfficers

11-9

Publicly Owned Corporations Publicly Owned Corporations Face Different RulesFace Different Rules By law, publicly owned corporations must:

Prepare financial statements in accordance with GAAP.

Have their financial statement audited by an independent CPA.

Comply with federal securities laws.Submit financial information for SEC review.

11-10

Stockholders usually meet once a year.Stockholders usually meet once a year.

Stockholder ledgers are often maintained by a stock transfer agent or stock registrar.

Stockholder ledgers are often maintained by a stock transfer agent or stock registrar.

Stockholder Records in a Stockholder Records in a CorporationCorporation

Each unit of ownership is called a share of stock.

Stock certificates serve as proof that a stockholder has purchased shares.

Each unit of ownership is called a share of stock.

Stock certificates serve as proof that a stockholder has purchased shares.

When the stock is sold, the stockholder signs a transfer endorsement on the back of the stock

certificate.

When the stock is sold, the stockholder signs a transfer endorsement on the back of the stock

certificate.

11-11

Paid-in Capital

Contributions byinvestors in exchange

for capital stock.

Retained Earnings

Retention of profitsearned by thecorporation.

Stockholders' equity isincreased in tw o ways.

Stockholders’ Equity of a Stockholders’ Equity of a CorporationCorporation

11-12

The maximum number of

shares of capital stock that can be

sold to the public.

AuthorizedShares

AuthorizedShares

Authorization and IssuanceAuthorization and Issuanceof Capital Stockof Capital Stock

11-13

Issued shares are authorized shares of stock that have been

sold.

Unissued shares are authorized shares of stock that

never have been sold.

Usually shares are

sold through an

underwriter.

Usually shares are

sold through an

underwriter.

AuthorizedShares

AuthorizedShares


11-14

UnissuedShares

UnissuedShares

TreasuryShares

OutstandingShares

Treasury shares are issued shares that

have been reacquired by the corporation.

Treasury shares are issued shares that

have been reacquired by the corporation.

IssuedSharesIssuedShares

Outstanding shares are issued shares that are

owned by stockholders.

Outstanding shares are issued shares that are

owned by stockholders.

AuthorizedShares

AuthorizedShares


11-15

Par value is an arbitrary amount assigned

to each share of stock when it is authorized.Market price is the amount that each share of stock will sell for in the market.

Par value is an arbitrary amount assigned

to each share of stock when it is authorized.Market price is the amount that each share of stock will sell for in the market.

Stockholders’ EquityStockholders’ Equity

11-16

Common stock can be issued in three forms:Common stock can be issued in three forms:

No-Par Common

Stock

No-Par Common

Stock

Par Value Common

Stock

Par Value Common

Stock

Stated Value Common

Stock

Stated Value Common

Stock

All proceeds credited to

Common Stock

All proceeds credited to

Common Stock

Treated like par value common

stock

Treated like par value common

stock

Stockholders’ EquityStockholders’ Equity

Let’s examine this form of stock.

Let’s examine this form of stock.

11-17

Assume a corporation issues 10,000 shares of its $2 par value stock for $25 per share.


Record:

1.The cash received.

2.The number of shares issued × the par value per share in the Common Stock account.

3.The remainder is assigned to Additional Paid-in Capital.

Record:

1.The cash received.

2.The number of shares issued × the par value per share in the Common Stock account.

3.The remainder is assigned to Additional Paid-in Capital.

Issuance of Par Value StockIssuance of Par Value Stock

11-18




Description Debit Credit

Cash 250,000 Common Stock 20,000 Additional Paid-in Capital 230,000

10,000 × $2 = $20,00010,000 × $2 = $20,000

11-19


Stockholders' Equity with Common StockStockholders' Equity

Contributed capital:

Common stock - $2 par value; 50,000 shares

authorized; 10,000 shares issued and

outstanding $ 20,000

Additional paid-in capital 230,000

Retained earnings 65,000

Total stockholders' equity $ 315,000

11-20

Preferred StockPreferred StockA separate class of stock, typically

having priority over common shares in . . .

Dividend distributions (rate is usually stated).

Distribution of assets in case of liquidation.

Cumulative dividend rights.

Cumulative dividend rights.

Normally has no voting

rights.

Normally has no voting

rights.

Usually callable by

the company.

Usually callable by

the company.

Other Features Include:

11-21

Vs. NoncumulativeCumulative

Dividends in arrears must be

paid before dividends may be paid on common

stock.

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.

Undeclared dividends from

current and prior years do not have to be paid in future

years.

Cumulative Preferred StockCumulative Preferred Stock

11-22

Example: Consider the following partial Statement of Stockholders’ Equity.

During 2008, the directors declare cash dividends of $5,000. In 2009, the directors

declare cash dividends of $42,000.

Stock Preferred as to Stock Preferred as to DividendsDividends

11-23

Stock Preferred as to Stock Preferred as to DividendsDividends

Preferred CommonIf Preferred Stock is Noncumulative:Year 2008 $5,000 dividends declared 5,000$ -$

Year 2009 Step 1: Current preferred dividend 9,000$

Step 2: Remainder to common shareholders 33,000$

If Preferred Stock is Cumulative:Year 2008 $5,000 dividends declared 5,000$ -$

Year 2009 Step 1: Dividends in arrears 4,000$ Step 2: Current preferred dividend 9,000 Step 3: Remainder to common shareholders 29,000$

Totals 13,000$ 29,000$

Preferred CommonIf Preferred Stock is Noncumulative:Year 2008 $5,000 dividends declared 5,000$ -$

Year 2009 Step 1: Current preferred dividend 9,000$

Step 2: Remainder to common shareholders 33,000$

If Preferred Stock is Cumulative:Year 2008 $5,000 dividends declared 5,000$ -$

Year 2009 Step 1: Dividends in arrears 4,000$ Step 2: Current preferred dividend 9,000 Step 3: Remainder to common shareholders 29,000$

Totals 13,000$ 29,000$

11-24

I just converted 100 shares of preferred stock into

1,000 shares of common stock and ended up with a

higher dividend yield!

I just converted 100 shares of preferred stock into

1,000 shares of common stock and ended up with a

higher dividend yield!

Some preferred stock is

convertible into shares of

common stock.

Other Features of Preferred Other Features of Preferred StockStock

11-25

Preferred StockPreferred StockStockholders' Equity with Common and Preferred StockStockholders' Equity Contributed Capital: Preferred Stock - $100 par value; 1,000 shares authorized; 50 shares issued and outstanding 5,000$ Common Stock - $10 par value; 50,000 shares authorized; 30,000 shares issued and outstanding 300,000 Additional Paid-in Capital 1,000 Retained Earnings 65,000 Total Stockholders' Equity 371,000$

11-26

Accounting by the issuer.

Accounting by the issuer.

Accounting by the investor.

Accounting by the investor.

Common stock is carried at original issue

price.

Common stock is carried at original issue

price.

Investments in marketable securities are carried at market

value.

Investments in marketable securities are carried at market

value.

Market ValueMarket Value

11-27

Market Price of Preferred Market Price of Preferred StockStock Factors affecting market price of Factors affecting market price of

preferred stock:preferred stock:• Dividend rateDividend rate• RiskRisk• Level of interest ratesLevel of interest rates

The return based on the market value is called the

“dividend yield.”

The return based on the market value is called the

“dividend yield.”

11-28

Factors affecting market price of common stock:Investors’

expectations of future profitability.

Risk that this level of profitability will not be achieved.

Factors affecting market price of common stock:Investors’

expectations of future profitability.

Risk that this level of profitability will not be achieved.

Changes in market value

have no impact on the books of the issuer.

Changes in market value

have no impact on the books of the issuer.

Market Price of Common Market Price of Common StockStock

11-29

Book Value per ShareBook Value per Shareof Common Stockof Common Stock

Total Stockholders’ EquityNumber of Common Shares Outstanding

Preferred stock and preferreddividends in arrears are deducted

from total stockholders’ equity.

Book Value Market Value≠

11-30

Ice Cream Parlor

Stock SplitsNow

Available

Stock SplitsStock Splits

Companies use stock splits to reduce market price.

Outstanding shares increase, but par value is decreased proportionately.

Companies use stock splits to reduce market price.

Outstanding shares increase, but par value is decreased proportionately.

11-31

Assume a corporation has 5,000 shares of $1 par value common stock

outstanding before a 2–for–1 stock split.

Increase

Decrease

No Change

Stock SplitStock Split

Before Split After Split

Common Stock Shares 5,000 10,000

Par Value per Share 1.00$ 0.50$

Total Par Value 5,000$ 5,000$

11-32

When stock is reacquired, the corporation records the treasury stock at cost.

When stock is reacquired, the corporation records the treasury stock at cost.

Treasury shares are

issued shares that have been reacquired

by the corporation.

Treasury shares are

issued shares that have been reacquired

by the corporation.

Treasury StockTreasury Stock

11-33


Treasury Stock 165,000 Cash 165,000 3,000 shares × $55 = $165,000

Riley Corporation reacquires 3,000 sharesof its common stock at $55 per share.Prepare the journal entry to record the

purchase of treasury stock.

Recording Purchases of Recording Purchases of Treasury StockTreasury Stock


Treasury Stock 165,000 Cash 165,000 3,000 shares × $55 = $165,000

11-34

Riley Corporation reissued 1,000 shares of the treasury stock originally purchased for $55 per share. The shares were reissued at

$75 per share.

Recording Purchases of Recording Purchases of Treasury StockTreasury Stock


Cash 75,000 Treasury Stock 55,000 Additional Paid-in Capital: Treasury Stock 20,000

1,000 shares × $55 cost = $55,0001,000 shares × $55 cost = $55,000

1,000 shares × $75 = $75,0001,000 shares × $75 = $75,000

11-35

Stockholders’ Equity Stockholders’ Equity PresentationPresentation

Stockholders' Equity Contributed capital: Preferred Stock - $100 par value; 1,000 shares authorized; 50 shares issued & outstanding 5,000$ Common Stock - $10 par value; 50,000 shares authorized; 30,000 shares issued and outstanding 300,000 Contributed Capital in Excess of Par 21,000 Retained earnings 65,000 Subtotal 391,000$ Less: Treasury stock 110,000 Total Stockholders' equity 281,000$

11-36

Stock Buyback ProgramsStock Buyback Programs

Some corporations have buyback programs, in which they repurchase large amounts of their own common stock. As a result of these programs, treasury stock has become a material item in the balance sheet of many corporations.

Stock option plans are an important part of employee compensation for many companies. Treasury stock purchases are an effective means by which the company can have available the shares of stock needed to satisfy the requirement of stock option plans to issue the shares of stock to employees.

Some corporations have buyback programs, in which they repurchase large amounts of their own common stock. As a result of these programs, treasury stock has become a material item in the balance sheet of many corporations.

Stock option plans are an important part of employee compensation for many companies. Treasury stock purchases are an effective means by which the company can have available the shares of stock needed to satisfy the requirement of stock option plans to issue the shares of stock to employees.

11-37

Financial Analysis andFinancial Analysis andDecision MakingDecision Making

Return on CommonStockholders’ Equity

Net Income – Preferred DividendsAverage Common Stockholders’ Equity

=

11-38

End of Chapter 11End of Chapter 11

Business

Chap011