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11–1
Chapter 11
Contributed Capital
11–2Copyright © Cengage Learning. All rights reserved.
Google, Inc.
Click here for information on the history of Google.
Created a national sensation with the largest IPO after the tech bust of 2002
Issued 22.5 million shares at $85 per share for a total of $1.9 billion
As you study this chapter, consider why you think Google decided to offer stock as a means to raise capital.
11–3Copyright © Cengage Learning. All rights reserved.
Management Issues Related to Contributed Capital
LO1
Corporation is a body of persons who have been granted a charter that recognizes the entity as having separate legal rights, privileges, and liabilities distinct from those of its members
Investments by stockholders, called contributed capital, is a major means of
financing for a corporation
11–4Copyright © Cengage Learning. All rights reserved.
Corporate Form of Business
Separation of ownership and control
Limited liability
Double taxation
More government regulation
DisadvantagesAdvantages
Centralized authority
Professional management
Continuous existence
Lack of mutual agency
Ease of transferring stock
Ease of raising capital
Separate legal entity
Limited liability
11–5Copyright © Cengage Learning. All rights reserved.
Using Equity Financing
A stock certificate is issued to the owner
Stockholder can transfer ownership at will
Independent registrars and transfer agents are often used to keep track of stockholders’ records
Stock Certificate Shows units of ownership in a
corporation
11–6Copyright © Cengage Learning. All rights reserved.
Par Value
Usually bears little or no relationship to the market value or book value of shares
Constitutes the legal capital of the corporation
– The number of shares issued times the par value
– The minimum amount that can be reported as contributed capital
An arbitrary amount assigned to each share of stock
11–7Copyright © Cengage Learning. All rights reserved.
Initial Public Offering (IPO)
acts between the corporation and investing public
Guarantees the sale of the stock for a fee
Underwriter
The corporation records the net proceeds of the offering
11–8Copyright © Cengage Learning. All rights reserved.
Costs to Start a Corporation?
Start-up and Organization
Costs
Start-up and Organization
Costs
State incorporation fees
Attorneys’ fees
Cost of printing stock certificates
Accountants’ fees related to registering the firm’s stock
A corporation’s life normally is not known, so these costs are expensed as incurred.
11–9Copyright © Cengage Learning. All rights reserved.
Dividends
Distribute to stockholders the assetsthat a corporation’s earnings have generated
Stockholders receive these assets,
usually cash, in proportion to the number of shares
they own
Board of directors declares dividends
Decision to declare dividends affected by
• cash flows,
• pending lawsuits,
• economic situation,
• or debt levels.
11–10Copyright © Cengage Learning. All rights reserved.
Dividend Dates
Date of Declaration
Date of Record
Payment Date
Board of directors formally declares that the corporation is going to pay a
dividend
Whoever owns the stock on
the record date will receive the
dividend
Date on which the dividend is
paid to the stockholders of
record
11–11Copyright © Cengage Learning. All rights reserved.
Dividend Yield Ratio
Shareper PriceMarket
Shareper Dividends Yield Dividends
%4.1$27.87
$0.40 Microsoft
Tells investors how much they can expect to receive in dividends expressed as a percentage of the
market price per share—what they can sell the stock for
11–12Copyright © Cengage Learning. All rights reserved.
Return on Equity Ratio
Most important ratio associated with stockholders’ equity Compensation of top executives often tied to return on
equity
Net IncomeAverage Stockholders’ Equity
$4,203,720($22,689,679 + $17,039,840) / 2
= 21.2%
=
=
Return on Equity
11–13Copyright © Cengage Learning. All rights reserved.
Price/Earnings (P/E) Ratio
A measure of investors’ confidence in a company’s future
Shareper Earnings
Shareper PriceMarket Ratio (P/E) Earnings Price
times16$1.74
$27.87 Microsoft
Because the market price is 16 times earnings, investors are paying a good price in relation to earnings. They do so in the expectation that
this software company will continue to be successful
11–14Copyright © Cengage Learning. All rights reserved.
Discussion: Ethics in the Business World
Companies with a code of ethics experienced far less P/E volatility over a four-year period, than those without them. This suggests that they may be a more secure investment in the longer term.
Source: Institute on Business Ethics, “Does Business Ethics Pay?” by Simon
Webley & Elise More
Q. If the P/E ratio is volatile, what factors may be at play?
A. Questionable management or accounting practices, dips in economic conditions
11–15Copyright © Cengage Learning. All rights reserved.
Stock Option Plans
Give employees the right to purchase stock in the future at a fixed price
A means of both motivating and compensating employees
On date of grant:
estimate fair value of options
Amount in excess of exercise price is
recorded as compensation
expense over the grant period
11–16Copyright © Cengage Learning. All rights reserved.
Stop & Review
Q. How is return on equity computed?
A. Divide net income by average stockholders’ equity.
11–17Copyright © Cengage Learning. All rights reserved.
Stop & Review
Q. What are three advantages to the corporate form of business organization?
A. Limited liability, ease of raising capital, ease of transferring ownership
11–18Copyright © Cengage Learning. All rights reserved.
Stop & Review
Q. What are the three important dates in regard to dividends?
A. Date of declaration, date of record, date of payment
11–19Copyright © Cengage Learning. All rights reserved.
Stop & Review
Q. How should a corporation treat its start-up and organization costs in the accounting records?
A. Expense as incurred
11–20Copyright © Cengage Learning. All rights reserved.
LO2 Components of Stockholders’ Equity
Contributed capital
Stockholders’ investments
Retained earnings Cumulative earnings, less any losses, dividends, or transfers to contributed capital
Treasury stock Shares of its own stock that the corporation has bought back on the open market
Three basic components:
11–21Copyright © Cengage Learning. All rights reserved.
Contributed Capital
Common Stock Preferred Stock
Basic form of stock that a corporation issues
if the corporation is liquidated, the claims of all creditors and of preferred stockholders rank above the claims of common stockholders
Gives owners preference over common stockholders, usually in
• receiving dividends
• in terms of claims to assets if the company is liquidated
11–22Copyright © Cengage Learning. All rights reserved.
Authorized, Issued, and Outstanding Shares
Contributed capitalPreferred stock, $50 par value, 1,000 shares authorized, issued, and outstanding
$50,000
Common stock, $5 par value, 30,000 shares authorized, 20,000 shares issued, 18,000 shares outstanding
$100,000
Additional paid-in capital 50,000 150,000
Total contributed capital $200,000
Stockholders’ Equity
Outstanding shares: Shares issued and still in
circulation (unlike treasury stock)
Issued shares: Sold or
transferred to stockholders
Authorized shares: Maximum number that the corporation’s
charter allows it to issue
11–23Copyright © Cengage Learning. All rights reserved.
Stop & Review
Q. Which part of stockholders’ equity shows a corporation’s earnings since its inception, less any losses, dividends, or transfers to contributed capital?
A. Retained earnings
11–24Copyright © Cengage Learning. All rights reserved.
Stop & Review
Q. Which class of stockholder has the least amount of claims in the event of liquidation of the corporation?
A. Common stockholders
11–25Copyright © Cengage Learning. All rights reserved.
LO3 Characteristics of Preferred Stock
Preference as to dividends Rights on liquidationConvertibility Callable option
11–26Copyright © Cengage Learning. All rights reserved.
Dividend Preference
Preferred stockholders receive their dividends before common stockholders receive anything
No guarantee of ever receiving dividendsConsequences of not declaring an annual dividend depends
on whether the preferred stock is:
CumulativeDividend amount per share accumulates from year to year; Company must pay the whole amount before it pays any dividends on common stock
NoncumulativeCompany is under no obligation to make up the missed dividend in future years
11–27Copyright © Cengage Learning. All rights reserved.
A corporation has 20,000 shares of $100 par, 5 percent cumulative preferred stock, its first year of operations outstanding. If the corporation pays no dividends in 2011, its first year of operations, preferred dividends in arrears at the end of the year would amount to $100,000.
(20,000 shares × $100 × .05)
Dividends in Arrears
Dividends not paid to cumulative preferred stock in the year they are due
If the corporation’s board declares dividends in 2012, the corporation must pay preferred stockholders the dividends in arrears plus their current year’s dividends before paying any dividends to common stockholders.
11–28Copyright © Cengage Learning. All rights reserved.
January 1, 2011: A corporation issued 20,000 shares of $10 par, 6 percent cumulative preferred stock and 100,000 shares common stock. The board of directors declared a $6,000 dividend to preferred stockholders after the first year of operations.
2011 dividends due preferred stockholders ($200,000 x .06) $12,000 Less 2011 dividends declared to preferred stockholders 6,000 2011 preferred stock dividends in arrears $6,000
Dividends in Arrears Illustrated
In 2012, the board of directors declared a $24,000 dividend to be distributed to preferred and common stockholders.
How much of the $24,000 can be given to common stockholders and how much belongs to preferred stockholders?
11–29Copyright © Cengage Learning. All rights reserved.
Dividends in Arrears Illustrated (cont’d)
2012 declaration of dividends $24,000 Less 2011 preferred stock dividends in arrears 6,000 Available for 2012 dividends $ 18,000 Less 2012 dividends due preferred stockholders ($200,000 x .06)
12,000
Remainder available to common stockholders $ 6,000
Record the journal entry for the declaration of the dividend:
Dec. 31 Dividends 24,000 Dividends Payable 24,000 Declared a $18,000 cash dividend to preferred
stockholders and a $6,000 cash dividend to common stockholders
11–30Copyright © Cengage Learning. All rights reserved.
Convertible Preferred Stock
Stockholder’s may exchange their shares of preferred stock for shares of common stock at the ratio stated in the company’s preferred stock contract
11–31Copyright © Cengage Learning. All rights reserved.
A company issued 1,000 shares of 8 percent, $100 par value convertible preferred stock for $100 per share. Each share can be converted into 5 shares of the company’s common stock at any time.
The market value of the common stock is now $15 per share and, in the past, the owner of common stock could expect dividends of $1 per share per year.
Per Share Stock Market Value Dividends
Common $15 $1 Preferred if converted to common
75
(5 shares x $15)
5
( 5 shares x $1)
Convertible preferred 100 8
At this point, the preferred stockholder receives more in dividends by keeping the preferred shares and is more likely to receive dividends than the common stockholders.
Convertible Preferred Stock Illustrated
11–32Copyright © Cengage Learning. All rights reserved.
A few years later, the dividends paid to common stockholders increase to $3 per share and market value is $30 per share.
Per Share Stock Market Value Dividends
Common $30 $ 3 Preferred if converted to common
150
(5 shares x $30)
15
( 5 shares x $3)
Convertible Preferred 100 8
At this point, the market value of each share of convertible preferred stock is equivalent to $150 and converting to common would increase dividend payments from $8 per share to the equivalent of $15.
Convertible Preferred Stock Illustrated (cont’d)
11–33Copyright © Cengage Learning. All rights reserved.
Callable Preferred Stock
redeemed or retired at the option of the corporation at a price stated in the preferred stock contract
call price > par value of the stock
Reasons to call stock
– A desire to pay lower dividends
– Because the corporation has enough profits to retire preferred stock
11–34Copyright © Cengage Learning. All rights reserved.
Stop & Apply
Q. Grant Corporation has 2,000 shares of $100 par value, 6 percent cumulative preferred stock outstanding and 100,000 shares of $1 par value common stock outstanding. No dividend was declared in 20x5. In 20x6, the board declared a dividend of $14,000. What amount will be paid to preferred stockholders in 20x6?
A. 20x6: Preferred dividends in arrears (2,000 shares × $100 × .06) $12,000
Current year to preferred 2,000
Total paid to preferred stockholders $14,000
11–35Copyright © Cengage Learning. All rights reserved.
LO4 Issuance of Common Stock
LO4
Account for the issuance of stock for cash and other assets.
11–36Copyright © Cengage Learning. All rights reserved.
LO4 Issuance of Common Stock with Par Value
Nocek Corporation is authorized to issue 10,000 shares of $10 par value common stock. The company issues 5,000 shares at $12
per share on January 1, 2010.
Jan. 1 Cash 60,000 Common Stock 50,000 Additional Paid-in Capital 10,000 Issued 5,000 shares of $10 par value
common stock for $12 per share
Par value is the amount per share that is recorded in a corporation’s capital stock accounts
11–37Copyright © Cengage Learning. All rights reserved.
Par Value Stock (continued)
Balance Sheet Presentation
Stockholders’ Equity Section
Contributed capital Common stock, $10 par value, 10,000 shares authorized, 5,000 shares issued and outstanding $50,000 Additional paid-in capital 10,000 Total contributed capital what stock sold for $60,000 Retained earnings — Total stockholders’ equity $60,000
11–38Copyright © Cengage Learning. All rights reserved.
Jan. 1 Cash 75,000 Common Stock 50,000 Additional Paid-in Capital 25,000 Issued 5,000 shares of no-par value
common stock with $10 stated value for $15 per share
Stated Value Stock
Assume Nocek’s board puts a $10 stated value on its no-par stock. It issues 5,000 shares at $15 per share on January 1, 2010.
Stated value of stock can be any value set by the board unless the state specifies a minimum amount.
11–39Copyright © Cengage Learning. All rights reserved.
No-Par Stock
Nocek Corporation is authorized to issue 20,000 shares of no-par common stock. Suppose the company issues 5,000 shares at $15 per share on January 1, 2010.
Jan. 1 Cash 75,000 Common Stock 75,000 Issued 5,000 shares of no-par
common stock for $15 per share
11–40Copyright © Cengage Learning. All rights reserved.
Issuance of Stock for Noncash Assets
Record at fair market value of what the corporation is giving up (stock)
or
If fair market value of the stock cannot be determined, use the fair market value of the assets or services received
Companies may issue stock for services or assets like buildings or land
11–41Copyright © Cengage Learning. All rights reserved.
When Nocek Corporation was formed on January 1, 2010, its attorney agreed to accept 200 shares of its $10 par value common stock for services rendered.
At the time the stock was issued, its market value could not be determined. For similar services, the attorney would have billed $3,000.
Jan. 1 Start-up and Organization Expense 3,000 Common Stock (200 x $10 par) 2,000 Additional Paid-in Capital 1,000 Issued 200 shares of $10 par
common stock for attorney’s services
Issuance of Stock for Noncash Assets
11–42Copyright © Cengage Learning. All rights reserved.
Stop & Review
Q. What is the difference between stated value and par value?
A. Par value is the amount per share that is recorded in a corporation’s capital stock accounts, and it constitutes a corporation’s legal capital. The stated value can be any value set by the board unless the state specifies a minimum amount, which is sometimes the case. The stated value can be set before or after the shares are issued if the state law is not specific.
11–43Copyright © Cengage Learning. All rights reserved.
Stop & Review
Q. If common stock is sold for an amount above par value, in which account is this amount recorded?
A. Additional Paid-in Capital
11–44Copyright © Cengage Learning. All rights reserved.
LO 5 Treasury Stock
more than 67 percent of large companies repurchase their own stock
Use the stock for employee stock option plans Want to maintain a favorable market for their stock
to increase earnings per share or stock price per share
to have additional shares of stock available for purchasing other companies
Attempt to prevent hostile takeovers
11–45Copyright © Cengage Learning. All rights reserved.
On Sept. 15, Amber Corporation purchases 2,000 shares of its common stock on the market for $50 per share.
When treasury stock is purchased, it is usually recorded at cost:
Sept. 15 Treasury Stock, Common 2000 shares x $50 cost 100,000 Cash 100,000 Acquired 2,000 shares of the
company’s common stock for $50 per share
Purchase of Treasury Stock Illustrated
11–46Copyright © Cengage Learning. All rights reserved.
Balance Sheet PresentationStockholders’ Equity SectionContributed capital Common stock, $5 par value, 200,000 shares authorized, 60,000 shares issued, 58,000 shares
outstanding
$300,000 Additional paid-in capital 60,000 Total contributed capital $360,000 Retained earnings 1,800,000 Total contributed capital and retained earnings $2,160,000 Less treasury stock, common (1,000 shares at cost) 100,000 Total stockholders’ equity $2,060,000
Notice that the number of shares issued, and therefore legal capital, has not changed even though the number of shares outstanding has decreased.
Purchase of Treasury Stock
11–47Copyright © Cengage Learning. All rights reserved.
Dec. 15: Amber Corporation sells 1,200 shares of its treasury stock for $52 per share. (Cost was $50 per share.)
Dec. 15 Cash ($52 x 1,200 shares) 62,400 Paid-in Capital, Treasury Stock 2,400 Treasury Stock, Common ($50 cost x 1200 shares) 60,000 Sold 1,200 shares of the treasury stock for
$52 per share; cost was $50 per share
When treasury shares are sold above cost, the difference (gain) is added to Paid-in Capital, Treasury Stock
Sale of Treasury Stock Above Cost
11–48Copyright © Cengage Learning. All rights reserved.
Dec. 15: Amber Corporation sells 1,200 shares of its treasury stock for $42 per share. (Cost was $50 per share.)
Dec. 15 Cash ($42 x 1200 shares) 50,400 Paid-in Capital, Treasury Stock 2,400 Retained Earnings 7,200 Treasury Stock ($50 cost x 1200 shares) 60,000 Sold 1,200 shares of the treasury stock
for $42 per share; cost was $50 per share
When treasury shares are sold below cost, the difference is deducted from Paid-in Capital, Treasury Stock
If the Paid-in Capital, Treasury Stock account cannot absorb the full amount of the difference, or doesn’t exist, Retained Earnings absorbs the remainder.
Sale of Treasury Stock Below Cost
11–49Copyright © Cengage Learning. All rights reserved.
Retirement of Treasury Stock
Treasury stock is retired when the company decides not reissue stock it has purchased
If acquisition price < original issue priceCredit Paid-In Capital, Retirement of Stock
If acquisition price > original issue price Debit Retained Earnings
11–50Copyright © Cengage Learning. All rights reserved.
Stop & Review
Q. Does the purchase of treasury stock change the legal capital of a corporation?
A. No, total shares issued has not changed, though the total number of shares outstanding has been decreased.
11–51Copyright © Cengage Learning. All rights reserved.
Stop & Review
Q. What are reasons that a company might buy back its own stock?
A. To use the stock for employee stock option plans, maintain a favorable market for its stock, increase earnings per share, or prevent a hostile takeover
11–52Copyright © Cengage Learning. All rights reserved.
Chapter Review Problem
Required: 1. Record the journal entry for the issuance of common stock in 20x6.2. What amount is paid to common and preferred stockholders in 20x7 for
dividends?
Riddle Corporation is authorized to issue 50,000 shares of $10 par value common stock and 20,000 shares of preferred stock. The
company issues 20,000 shares at $15 per share on January 1, 20x6. Later that year, the company issues 10,000 shares of $10 par value 6 percent cumulative preferred stock. The board declared cash dividends of $14,000 in 20x7.
11–53Copyright © Cengage Learning. All rights reserved.
Chapter Review Problem (Solution)
Jan. 1 Cash 300,000 Common Stock 200,000 Additional Paid-in Capital 100,000 Issued 20,000 shares of $10 par value
common stock for $15 per share
20x7: Preferred dividends in arrears from 20x6 (10,000 shares x $10 x .06) $ 6,000Current year preferred dividends (10,000 shares x $10 x .06) 6,000Total to be distributed to preferred stockholders $12,000Remainder to be distributed to common stockholders 2,000 Total to be distributed $14,000
1.
2.