Ch. 11 Synchronotes for Fundamentals of Financial Accounting,
3eby Phillips/Libby/Libby
Chapter 11: Reporting and Interpreting Stockholders’ Equity
Corporate Ownership
The major advantage of the corporate form of business is the
ease of raising capital as both large and small investors can
participate in corporate ownership.
1. Simple to become an owner
2. Easy to transfer ownership
3. Provides limited liability
20082009
Stockholders' Equity
Common Stock100,000$ 100,000$
Additional Paid-in Capital750,000 750,000
Retained Earnings50,000 (70,000)
Total Stockholders' Equity900,000 780,000
Baker Company
Comparative Balance Sheets (Partial)
For Year Ended December 31
Because a corporation is a separate legal entity, it can 1) own
assets, 2) incur liabilities, 3) sue and be sued, and enter into
contracts.
Stockholder Benefits:
1. Voting Rights
2. Dividends
3. Residual Claims
4. Preemptive rights
Equity Versus Debt Financing
Advantages of equity
1) Equity does not have to be repaid. 2) Dividends are
optional.
Advantages of debt
1) Interest on debt is tax deductible. 2) Debt does not change
stockholder control.
Common Stock Transactions
Two primary sources of Stockholders’ Equity
1. Contributed Capital – Common Stock, Additional Paid-in
Capital
2. Retained Earnings
Authorization, Issuance, and Repurchase of Stock
Authorized Shares:
· Outstanding Shares – Shares that are owned by stockholders
· Treasury Shares – Issued shares that have been reacquired by
the corporation
· Unissued Shares – Authorized but not yet issued
Stock Authorization
Par value is typically a very nominal amount such a $0.01 per
share.
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 ≠ Market price
No-par Stock: Some states do not require a par value to be
stated in the charter.
Stock Issuance
Initial public offering (IPO): The first time a corporation
issues stock to the public.
Seasoned new issue: Subsequent issues of new stock to the
public.
Most issues of stock to the public are cash transactions.
National Beverage issued 100,000 shares of $0.01 par value
common stock for $10 per share.
Stock Exchanged between Investors
Transactions between two investors do not affect the
corporation’s accounting records.
Repurchase of Stock
A corporation repurchases its stock to:
·
EPSROEP/E
National Beverage0.49$ 14.9%15.8
Pepsico3.26$ 34.8%16.0
2008
Total dividend declared400,000$
Preferred stock (cumulative)
In Arrears($1 par × 7% × 100,000 shares)7,000$
Current Yr.($1 par × 7% × 100,000 shares)7,000 14,000
Remainder386,000$
Common stock386,000
Remainder-$
Send a signal that the company believes its stock is
undervalued.
· Obtain shares to reissue for the purchase of other
companies.
· Obtain shares to reissue to employees as part of stock
purchase or stock option plans.
When stock is reacquired, the corporation records the treasury
stock at cost.
· No voting or dividend rights
· Contra equity account - Treasury stock is not an asset.
National Beverage reacquired 50,000 shares of its common stock
at $25 per share.
Reissuance of Treasury Stock
National Beverage reissued 5,000 shares of the Treasury Stock at
$26 per share.
No profit or loss is recognized on treasury stock
transactions.
Dividends on Common Stock
· Declared by the Board of Directors
· Not Legally Required
· Creates a Liability at Declaration
· Requires Sufficient Retained Earnings and Cash
Restrictions on Retained Earnings
Loan agreements can include restrictions on paying dividends
below a certain amount of retained earnings.
Dividends Dates
National Beverage declares an $0.80 dividend on each share of
its 46,000,000 shares of common stock outstanding.
National Beverage paid the previously declared $0.80 dividend on
its shares of common stock outstanding.
Stock Dividends
Distribution of additional shares of stock to stockholders.
· No change in total stockholders’ equity.
· All stockholders retain same percentage ownership.
· No change in par values.
Corporations issue stock dividends to:
· Remind stockholders of the accumulating wealth in the
company.
· Reduce the market price per share of stock.
· Signal that the company expects strong financial performance
in the future.
Small – Stock dividend <20-25% - Record at current market
value of stock.
Large – Stock dividend >20-25% - Record at par value of
stock.
2-for-1 Stock100% Stock$10,000 Cash
Stockholders' EquityBeforeSplitDividendDividend
Contributed Capital
Number of common shares
outstanding1,000,000 2,000,000 2,000,000 1,000,000
Par value per common share0.01$ 0.005$ 0.01$ 0.01$
Common stock, at par10,000$ 10,000$ 20,000$ 10,000$
Additional paid-in capital30,000 30,000 30,000 30,000
Retained Earnings650,000 650,000 640,000 640,000
Total stockholders' equity690,000$ 690,000$ 690,000$
680,000$
After
The journal entry moves an amount from Retained Earnings to
other equity accounts.
National Beverage issued a 20 percent stock dividend on
38,000,000 outstanding shares of its $0.01 par value common stock
and accounted for it as a large stock dividend.
Stock Splits
An increase in the number of shares and a corresponding decrease
in par value per share. Retained earnings is not affected.
A stock split creates more pieces of the same pie.
Assume that a corporation had 5,000 shares of $1 par value
common stock outstanding before a 2–for–1 stock split.
Comparison of Distributions to Stockholders
Preferred Stock Issuance
Preferred Stock:
· Priority over common stock
· Usually has a fixed dividend rate
· Usually has no voting rights
National Beverage issued 10,000 shares of its $1 par value
preferred stock for $5 per share.
Preferred Stock Dividends
Current Dividend Preference: The current preferred dividends
must be paid before paying any dividends to common stock.
Cumulative Dividend Preference: Any unpaid dividends from
previous years (dividends in arrears) must be paid before common
dividends are paid.
If the preferred stock is noncumulative, any dividends not
declared in previous years are lost permanently.
In addition to its common stock, National Beverage has $1 par
value cumulative preferred stock with a 7 percent dividend rate.
Assume 100,000 of these shares are outstanding, one year of
dividends are in arrears, and the board of directors just declared
total dividends of $400,000.
How much will each class of stock receive?
Retained Earnings
Total cumulative amount of reported net income less any net
losses and dividends declared since the company started
operating.
Baker Company incurred a loss of $120,000 in 2009 that resulted
in an Accumulated Deficit in Retained Earnings.
Earnings Per Share (EPS)
Earnings per share is probably the single most widely watched
financial ratio.
National Beverage’s income for 2008 was $22,500,000 and the
average number of shares outstanding during the year was
45,900,000.
Return on Equity (ROE)
Return on equity is the amount earned for each dollar invested
by stockholders.
National Beverage’s income for 2008 was $22,500,000 and the
average Stockholders’ Equity was $151,000,000.
Price/Earnings (P/E) Ratio
The P/E ratio is a measure of the value that investors place on
a company’s common stock.
National Beverage’s stock price was $7.74 when the company
reported its 2008 EPS of $0.49.
Comparison of EPS, ROE, and P/E Ratios
2-for-1 Stock100% Stock$10,000 Cash
Stockholders' EquityBeforeSplitDividendDividend
Contributed Capital
Number of common shares
outstanding1,000,000 2,000,000 2,000,000 1,000,000
Par value per common share0.01$ 0.005$ 0.01$ 0.01$
Common stock, at par10,000$ 10,000$ 20,000$ 10,000$
Additional paid-in capital30,000 30,000 30,000 30,000
Retained Earnings650,000 650,000 640,000 640,000
Total stockholders' equity690,000$ 690,000$ 690,000$
680,000$
After
Owner’s Equity for a Sole Proprietorship
Only two owner’s equity accounts.
1. A capital account to record the owner’s investments and the
periodic income or loss - No separate retained earnings
account.
2. A withdrawal account to record the owner’s withdrawals of
assets. - Closed to the capital account at the end of each
period.
Accounting for Owner’s Equity for a Sole Proprietorship
To record a $150,000 investment by H. Simpson, the owner.
To record H. Simpson’s $1,000 monthly withdrawal.
To close revenue and expense accounts to capital.
To close the $1,000 monthly drawings to capital.
Accounting for Partnership Equity
Accounting for assets, liabilities, revenues and expenses
follows the same accounting principles as any other form of
business.
Accounting for partners’ equity follows the same pattern as for
a sole proprietorship.
Separate capital and drawings accounts are maintained for each
partner.
Total dividend declared400,000$
Preferred stock (cumulative)
In Arrears($1 par × 7% × 100,000 shares)7,000$
Current Yr.($1 par × 7% × 100,000 shares)7,000 14,000
Remainder386,000$
Common stock386,000
Remainder-$
To record investments by partners Able and Baker who will divide
net income as follows: Able, 60 percent and Baker 40 percent.
To record the partners’ monthly withdrawal.
To close revenue and expense accounts to partners’ capital.
To close the monthly drawings to partners’ capital.
Other Business Forms
Limited Liability Partnership (LLP)
· Protects innocent partners from malpractice or negligence
claims.
· Most states hold all partners personally liable for
partnership debts.
Limited Liability Company (LLC)
· Owners have same limited liability feature as owners of a
corporation.
· A limited liability company typically has a limited life.
Exercises
M11-4 Analyzing and Recording the Issuance of Common Stock
To expand operations, Aragon Consulting issued 100,000 shares of
previously unissued common stock with a par value of $1. The price
for the stock was $75 per share. Analyze the accounting equation
effects and record the journal entry for the stock issuance.
Would your answer be different if the par value were $2 per
share? If, so, analyze the accounting equation effects and record
the journal entry for the stock issuance with a par value of
$2.
M11-8 Determining the Amount of a Dividend
Netpass Company has 300,000 shares of common stock authorized,
270,000 shares issued, and 100,000 shares of treasury stock. The
company’s board of directors declares a dividend of 50 cents per
share of common stock. What is the total amount of the dividend
that will be paid?
E11-3 Preparing the Stockholders’ Equity Section of the Balance
Sheet
North Wind Aviation received its charter during January 2010.
The charter authorized the following capital stock:
During 2010, the following transactions occurred in the order
given:
a. Issued a total of 40,000 shares of the common stock to the
company’s founders for $11 per share.
b. Issued 5,000 shares of the preferred stock at $18 per
share.
c. Issued 3,000 shares of the common stock at $14 per share and
1,000 shares of the preferred stock at $28.
d. Net income for the first year was $48,000.
Required:
Prepare the stockholders’ equity section of the balance sheet at
December 31, 2010.
E11-6 Recording and Reporting Stockholders’ Equity
Transactions
AvA School of Learning obtained a charter at the start of 2010
that authorized 50,000 shares of no-par common stock and 20,000
shares of preferred stock, par value $10. During 2010, the
following selected transactions occurred:
a. Collected $40 cash per share from four individuals and issued
5,000 shares of common stock to each.
b. Issued 6,000 shares of common stock to an outside investor at
$40 cash per share.
c. Issued 8,000 shares of preferred stock at $20 cash per
share.
Required:
1. Give the journal entries indicated for each of these
transactions.
2. Prepare the stockholders’ equity section of the balance sheet
at December 31, 2010. At the end of 2010, the accounts reflected
net income of $36,000. No dividends were declared.
E11-8 Recording Treasury Stock Transactions and Analyzing Their
Impact
During 2010, the following selected transactions affecting
stockholders’ equity occurred for Corner Corporation:
Feb. 1 Purchased 400 shares of the company’s own common stock at
$22 cash per share.
Jul. 15
Issued 100 of the shares purchased on February 1, 2010, for $24
cash per share.
Sept. 1
Issued 60 more of the shares purchased on February 1, 2010, for
$20 cash per share.
Required:
1. Show the effects of each transaction on the accounting
equation.
2. Give the indicated journal entries for each of the
transactions.
3. What impact does the purchase of treasury stock have on
dividends paid?
4. What impact does the issuance of treasury stock for an amount
higher than the purchase price have on net income?
E11-11 Recording the Payment of Dividends and Preparing a
Statement of Retained Earnings
The 2009 annual report for Sneer Corporation disclosed that the
company declared and paid preferred dividends in the amount of
$119.9 million in 2009. It also declared and paid dividends on
common stock in the amount of $2 per share. During 2009, Sneer had
1,000,000,000 shares of common authorized; 387,570,300 shares had
been issued; 41,670,300 shares were in treasury stock. The balance
in Retained Earnings was $1,554 million on December 31, 2008, and
2009 Net Income was $858 million.
Required:
1. Prepare journal entries to record the declaration, and
payment, of dividends on (a) preferred and (b) common stock.
2. Using the information given above, prepare a statement of
retained earnings for the year ended December 31, 2009.
E11-20 Determining the Effect of a Stock Repurchase on EPS and
ROE
Swimtech Pools Inc. (SPI) reported the following in its
financial statements for the quarter ended March 31, 2010.
During the quarter ended March 31, 2010, SPI reported Net Income
of $5,000 and declared and paid cash dividends totaling $5,000.
Required:
1. Calculate earnings per share (EPS) and return on equity (ROE)
for the quarter ended March 31, 2010.
2. Assume SPI repurchases 10,000 of its common stock at a price
of $2 per share on April 1, 2010. Also assume that during the
quarter ended June 30, 2010, SPI reported Net Income of $5,000, and
declared and paid cash dividends totaling $5,000. Calculate
earnings per share (EPS) and return on equity (ROE) for the quarter
ended June 30, 2010.
3. Based on your calculations in requirements 1 and 2, what can
you conclude about the impact of a stock repurchase on EPS and
ROE?
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Called
Treasury Stock
when repurchased
20082009
Stockholders' Equity
Common Stock100,000$ 100,000$
Additional Paid-in Capital750,000 750,000
Retained Earnings50,000 (70,000)
Total Stockholders' Equity900,000 780,000
Baker Company
Comparative Balance Sheets (Partial)
For Year Ended December 31
EPSROEP/E
National Beverage0.49$ 14.9%15.8
Pepsico3.26$ 34.8%16.0
2008
_1314360429.xls
Sheet1
Baker Company
Comparative Balance Sheets (Partial)
For Year Ended December 31
20082009
Stockholders' Equity
Common Stock$ 100,000$ 100,000
Additional Paid-in Capital750,000750,000
Retained Earnings50,000(70,000)
Total Stockholders' Equity900,000780,000
_1314360790.xls
Sheet1
2008
EPSROEP/E
National Beverage$ 0.4914.9%15.8
Pepsico$ 3.2634.8%16.0
_1314360379.xls
Sheet1
Total dividend declared$ 400,000
Preferred stock (cumulative)
In Arrears($1 par × 7% × 100,000 shares)$ 7,000
Current Yr.($1 par × 7% × 100,000 shares)7,00014,000
Remainder$ 386,000
Common stock386,000
Remainder$ -
&A
Page &P
_1314360147.xls
Sheet1
After
2-for-1 Stock100% Stock$10,000 Cash
Stockholders' EquityBeforeSplitDividendDividend
Contributed Capital
Number of common shares
outstanding1,000,0002,000,0002,000,0001,000,000
Par value per common share$ 0.01$ 0.005$ 0.01$ 0.01
Common stock, at par$ 10,000$ 10,000$ 20,000$ 10,000
Additional paid-in capital30,00030,00030,00030,000
Retained Earnings650,000650,000640,000640,000
Total stockholders' equity$ 690,000$ 690,000$ 690,000$
680,000
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