Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Shareholders’ Equity 18...

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

Shareholders’ Equity

18Insert Book Cover

Picture

18-2

Learning Objectives

Describe the components of shareholders’ equity and explain how they are reported in a

statement of shareholders’ equity.

18-3

The Nature of Shareholders’ Equity

Assets – Liabilities = Shareholders’ Equity

Net Assets(Residual Interest)

18-4

Sources of Shareholders’ Equity

Shareholders’ Equity

Paid-in Capital

Retained Earnings

Amounts earnedby corporation

Amounts investedby shareholders

Accumulated OtherComprehensive Income

Other gains and losses not included in net income

18-5

The Corporate Organization

Advantages: Ease of raising capital. Ease of ownership transfer. Limited liability. Continuous existence.

Disadvantages: Double taxation. Government regulation.

Advantages: Ease of raising capital. Ease of ownership transfer. Limited liability. Continuous existence.

Disadvantages: Double taxation. Government regulation.

18-6

Types of Corporations

Not-for-profit corporations includehospitals, charities, and government

agencies such as FDIC.

Privately-held corporationswhose shares are owned by

only a few individuals.

Publicly-held corporationswhose shares are widely

owned by the general public.

18-7

Hybrid Organizations

S Corporation Limited liability protection of a corporation. Maximum number of owners.

Limited liability company Limited liability protection of a corporation. All owners may be involved in management

without losing limited liability protection. No limit on number of owners.

Limited liability partnership Owners are liable for their own actions but not

entirely liable for actions of other partners.

S Corporation Limited liability protection of a corporation. Maximum number of owners.

Limited liability company Limited liability protection of a corporation. All owners may be involved in management

without losing limited liability protection. No limit on number of owners.

Limited liability partnership Owners are liable for their own actions but not

entirely liable for actions of other partners.

Doubletaxationavoided.

18-8

Formation of a Corporation

Number and classesof shares authorized.

Composition of initialboard of directors.

Nature and locationof business activities.

CorporateCharter

18-9

Formation of a Corporation

Articles of incorporationare filed with the state.

Board of directors elected by

shareholders.

Board of directors appoint officers.

Shares of stock issued.

State issues a corporate charter.

18-10

Fundamental Share Rights

Rightto vote.

Right to sharein distribution of

assets if companyis liquidated.

Right to sharein profits whendividends are

declared.

Preemptiveright to maintain

percentageownership.

18-11

Authorized, Issued, and Outstanding Capital Stock

AuthorizedShares

The maximum number of shares of capital

stock that can be sold to the public is called

the authorized number of shares.

18-12

Issued shares are authorized shares of stock that have been

sold.

Unissued shares are authorized shares of stock that have never been sold.

AuthorizedShares


18-13

UnissuedShares

TreasuryShares

OutstandingShares

Treasury shares are issued shares that have been reacquired by the

corporation.

IssuedShares

Outstanding shares are issued shares that are

owned by shareholders.Authorized

Shares


18-14

UnissuedShares

RetiredShares

OutstandingShares

Retired shares assume the same status as

authorized but unissued shares.

Outstanding shares are issued shares that are

owned by stockholders.Authorized

Shares


18-15

Capital Stock

Par value stock Designated dollar

amount per share stated in the corporate charter.

Par value has no relationship to market value.

Par value stock Designated dollar

amount per share stated in the corporate charter.

Par value has no relationship to market value.

No-par stock Dollar amount per

share not designated in corporate charter.

Corporations can assign a stated value per share (treated as if par value).

No-par stock Dollar amount per

share not designated in corporate charter.

Corporations can assign a stated value per share (treated as if par value).

18-16

Legal capital is . . . The portion of shareholders’ equity that

must be contributed to the firm when stock is issued.

The amount of capital, required bystate law, that must remain investedin the business.

Refers to par value, stated value,or full amount paid for no-par stock.

Legal capital is . . . The portion of shareholders’ equity that

must be contributed to the firm when stock is issued.

The amount of capital, required bystate law, that must remain investedin the business.

Refers to par value, stated value,or full amount paid for no-par stock.

Capital Stock

18-17

Types of Capital Stock

Common Preferred

18-18

The basic voting stock of the corporation.

Ranks after preferred stock for dividend and liquidation distribution.

Dividends determined by the board of directors.

The basic voting stock of the corporation.

Ranks after preferred stock for dividend and liquidation distribution.

Dividends determined by the board of directors.

Common Stock

18-19

Preferred Stock

Dividend andliquidation

preference over common stock.

Dividend andliquidation

preference over common stock.

Generally does nothave voting rights.Generally does nothave voting rights.

Usually has apar or stated value.

Usually has apar or stated value.

May be convertible,callable, and/or

redeemable.

May be convertible,callable, and/or

redeemable.

18-20

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.

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.

Preferred Stock Dividends

18-21

Preferred Stock DividendsCumulative

Unpaid dividends must be paid in full before any distributions to common stock.

Dividends in arrears are not liabilities, but the per share and aggregate amounts must be

disclosed.

18-22

Learning Objectives

Describe comprehensive income and its components.

18-23

Comprehensive Income

Comprehensive income includes four typesof gains and losses that traditionally have

been excluded from net income.

Comprehensive income includes four typesof gains and losses that traditionally have

been excluded from net income.

Net holding gains (losses)

on investments.

Net holding gains (losses)

on investments.

Deferred gains (losses) from derivatives.

Deferred gains (losses) from derivatives.

Net unrecognized

loss on pensions.

Net unrecognized

loss on pensions.

Gains (losses) from foreign

currency translations.

Gains (losses) from foreign

currency translations.

18-24


Components of comprehensive income created during the reporting period:

($ in millions)

Net income $xxxOther comprehensive income: Net unrealized holding gains (losses) on investments (net of tax)† $ x Net unrecognized loss on pensions (net of tax)‡ (x) Deferred gains (losses) from derivatives (net of tax)§ x Gains (losses) from foreign currency translation (net of tax)* x xxComprehensive income $xxx

† Changes in the market value of securities available-for-sale.‡ Reporting a pension liability sometimes requires recording this (described in Chapter 17).

It often is called pension liability adjustment.§ When a derivative designated as a cash flow hedge is adjusted to fair value, the gain or

loss is deferred as a component of comprehensive income and included in earnings later, at the same time as earnings are affected by the hedged transaction (described in the Derivatives Appendix to the text).

* Gains or losses from changes in foreign currency exchange rates. The amount could be an addition to or reduction in shareholders’ equity. (This item is discussed elsewhere in your accounting curriculum.)

18-25

Comprehensive income is reported periodically as it is created and also is reported as a cumulative amount.

Comprehensive income is reported periodically as it is created and also is reported as a cumulative amount.


There are 3 options for reporting comprehensive income created during the

reporting period.

There are 3 options for reporting comprehensive income created during the

reporting period.

The accumulated amount of comprehensive income is

reported as a separate item of shareholders’ equity in the

balance sheet.

The accumulated amount of comprehensive income is

reported as a separate item of shareholders’ equity in the

balance sheet.

As a separate statement ina disclosure

note.

As a separate statement ina disclosure

note.

As an additional section of the

income statement.

As an additional section of the

income statement.

As part of the statement of

shareholders’ equity.

As part of the statement of


18-26

Learning Objectives

Record the issuance of shares when sold for cash, for noncash consideration, and by share

purchase contract.

18-27

Issuing Stock for Cash

10,000 shares of $1 par value stock is issued for $100,000 cash.

10,000 shares of $1 par value stock is issued for $100,000 cash.

18-28


10,000 shares of no-par stock is issued for $100,000 cash.

10,000 shares of no-par stock is issued for $100,000 cash.

18-29


10,000 shares of no-par stock, with a stated value of $1 is issued for $100,000 cash.

10,000 shares of no-par stock, with a stated value of $1 is issued for $100,000 cash.

18-30

Issuing Stock for Noncash Assets

Apply the general valuation principle by using fair value of stock given up or fair value of asset received, whichever is more clearly

evident.

If market values cannot be determined, use appraised values.

Apply the general valuation principle by using fair value of stock given up or fair value of asset received, whichever is more clearly

evident.

If market values cannot be determined, use appraised values.

18-31More Than One Security Issuedfor a Single Price

Allocate the lump-sum received based on the relative fair values of the two securities.

If only one fair value is known, allocate a portion of the lump-sum received based on that fair value and allocate the remainder to the other security.

Allocate the lump-sum received based on the relative fair values of the two securities.

If only one fair value is known, allocate a portion of the lump-sum received based on that fair value and allocate the remainder to the other security.

18-32

Toys, Inc. issued 5,000 shares of common stock, $10 par value and 3,000 shares of

preferred stock, $5 par value for $450,000. The market values of the common stock and preferred stock were $55 and $75,

respectively.

Calculate the additional paid-incapital for each class of stock.

Toys, Inc. issued 5,000 shares of common stock, $10 par value and 3,000 shares of

preferred stock, $5 par value for $450,000. The market values of the common stock and preferred stock were $55 and $75,

respectively.

Calculate the additional paid-incapital for each class of stock.

More Than One Security Issuedfor a Single Price

18-33

Market* % Allocation** Par^ Excess^^Common Stock 275,000$ 55% 247,500$ 50,000$ 197,500$Preferred Stock 225,000 45% 202,500 15,000 187,500

Total 500,000$ 100% 450,000$ 65,000$ 385,000$

* Market Value: ^ Par Value: Common: $55 × 5,000 shares Common: $10 × 5,000 shares Preferred: $75 × 3,000 shares Preferred: $5 × 3,000 shares

**Allocation: ^^Excess: Common: $450,000 × 55% Common: $247,500 - $50,000 par Preferred: $450,000 × 45% Preferred: $202,500 - $15,000 par

Record the journal entry for issuing the stock.


18-34

GENERAL JOURNAL

Page 1

Date Description PR Debit Credit

Cash 450,000 Common Stock, par $10 50,000 Preferred Stock, par $5 15,000 Additional paid-in capital, Common Stock 197,500 Additional paid-in capital Preferred Stock 187,500

To record issue of stock for cash


18-35

Share Issue Costs

Share issue costs reduce net proceedsfrom selling shares, resulting in a lower

amount of additional paid-in capital.

Registration fees Underwriter commissions Printing and clerical costs Legal and accounting fees Promotional costs

18-36

Share Purchase Contracts

An agreement between a corporation anda subscriber whereby shares are sold in exchange for a promissory note.

An agreement between a corporation anda subscriber whereby shares are sold in exchange for a promissory note.

Dow Industrial sold 100,000 shares of its$1 par value stock for $10 using a share

purchase contract. Forty percent of the saleprice was collected at sale and sixty

percent will be received in six months.

Prepare the journal entry for this transaction.

Dow Industrial sold 100,000 shares of its$1 par value stock for $10 using a share

purchase contract. Forty percent of the saleprice was collected at sale and sixty

percent will be received in six months.

Prepare the journal entry for this transaction.

18-37

Share Purchase Contracts

The receivable is not an asset.It is reported as reduction in paid-in capital.

The receivable is not an asset.It is reported as reduction in paid-in capital.

18-38

Let’s turn ourattention toreacquiring

shares.

18-39

Share Buybacks

A corporation might reacquire shares of its stock to . . . Support the market price. Increase earnings per share. Distribute in stock option plans. Issue as a stock dividend. Use in mergers and acquisitions. Thwart takeover attempts.

A corporation might reacquire shares of its stock to . . . Support the market price. Increase earnings per share. Distribute in stock option plans. Issue as a stock dividend. Use in mergers and acquisitions. Thwart takeover attempts.

18-40

I can account forthe reacquired sharesby retiring them or by

holding them astreasury shares.

Share Buybacks

18-41

Learning Objectives

Describe what occurs when shares are retired and how retirement is recorded.

18-42

Accounting for Retired Shares

When shares are formally retired, we reduce the same capital accounts that were

increased when the shares were issued – common or preferred stock, and additional

paid-in capital.

18-43

5,000 shares of $2 par value stock that were issued for $20 per share are reacquired for $17 per share.


Price paid is less than issue price.


18-44

Price paid is more than issue price.




Reduce Retained Earnings if the Paid-in Capital – Share Repurchase

account balance is insufficient.

18-45

Learning Objectives

Distinguish between accounting for retired shares and for treasury shares.

18-46

Treasury Stock

Usually does not have: Voting rights. Dividend rights. Preemptive rights. Liquidation rights.

Reduces both assets andshareholders’ equity.

18-47

Acquisition of Treasury Stock Recorded at cost to acquire.

Resale of Treasury Stock Treasury Stock credited for cost. Difference between cost and

issuance price is (generally)recorded in paid-in capital –share repurchase.

Acquisition of Treasury Stock Recorded at cost to acquire.

Resale of Treasury Stock Treasury Stock credited for cost. Difference between cost and

issuance price is (generally)recorded in paid-in capital –share repurchase.

Accounting for Treasury Stock

18-48

On 5/1/05, Photos-in-a-Second reacquired 3,000 shares of its common stock at $55 per share. On 12/3/06, Photos-in-a-Second reissued 1,000 shares of the stock at $75 per share. Which of the following would be included in the 12/3 entry?

a. Credit Cash for $165,000.b. Debit Treasury Stock for $75,000.c. Credit Treasury Stock for $55,000.d. Credit Cash for $75,000.




18-49





Solution


18-50


18-51

Reporting Treasury Stock

Reported in Shareholders’ Equity.

Unallocated reductionof total Shareholders’Equity.

Reported in Shareholders’ Equity.

Unallocated reductionof total Shareholders’Equity.

18-52

Learning Objectives

Describe retained earnings and distinguishit from paid-in-capital.

18-53

Retained Earnings

Represents the undistributed earnings of the company since its inception.

Represents the undistributed earnings of the company since its inception.

Balance January 1, 2006 $ 500,000 Net income 25,000 Cash dividends (10,000) Balance December 31, 2006 515,000$

18-54

Retained Earnings

The statement of retained earnings may also contain the correction of an accounting error that occurred in the financial statements of a prior period, called a prior period adjustment.

Any restrictions on retained earningsmust be disclosed in the notes to the financial statements.

The statement of retained earnings may also contain the correction of an accounting error that occurred in the financial statements of a prior period, called a prior period adjustment.

Any restrictions on retained earningsmust be disclosed in the notes to the financial statements.

18-55Example: Shareholders’ EquitySection of a Balance Sheet

18-56

Learning Objectives

Explain the basis of corporate dividends, including the similarities and differences between cash and property dividends.

18-57

Cash Dividends

Dividends must bedeclared by the board

of directors beforethey can be paid.

When a dividend isdeclared, a liability

is created.

A corporation is notlegally required to

pay dividends.

Cash dividendsrequire sufficient cashand retained earningsto cover the dividend.

18-58

Dividend Dates

Declaration date Board of directors declares

the dividend. Record a liability.

GENERAL JOURNAL Page 12

Date DescriptionPost. Ref. Debit Credit

Retained Earnings XXX

Dividends Payable XXX

18-59

Dividend Dates

Ex-dividend date The first day the shares trade without the

right to receive the declared dividend.(No entry)

July

X

18-60

Dividend Dates

Date of record Stockholders holding shares on this date

will receive the dividend. (No entry)

July

X X

July

18-61

Dividend Dates

Date of payment Record the payment of the

dividend to stockholders.



Dividends Payable XXX

Cash XXX

18-62

Property Dividends

Distributions of non-cash assets.

Record at fair value of non-cash asset.

Recognize gain or loss for difference between book value and fair value.

Distributions of non-cash assets.

Record at fair value of non-cash asset.

Recognize gain or loss for difference between book value and fair value.

18-63

Learning Objectives

Explain stock dividends and stock splitsand how they are accounted for.

18-64

Stock Dividends

All shareholders receive the same

percentage increase in shares.

All shareholders receive the same

percentage increase in shares.

No change in total shareholders’ equity.No change in total


Distribution of additional shares of stock to shareholders.

18-65

Stock Dividends

Reasons for stock dividends:

To preserve cash.

To decrease market priceof stock.

To reduce existing balance in retained earnings.

18-66

Record at currentmarket value

of stock.

Record at currentmarket value

of stock.

Stock dividend < 25%Stock dividend < 25%

Stock Dividends

Stock dividend 25%Stock dividend 25%

Record at par or stated value

of stock.

Record at par or stated value

of stock.

Small Large

>

18-67

Stock Dividends

CarCo declares and distributes a 20% stock dividend on 5 million common

shares. Par value is $1 and market value is $20. Prepare the required journal entry.



18-68

Stock Dividends



Retained Earnings 20,000,000

Common Stock 1,000,000

Paid-in Capital in

Excess of Par 19,000,000

CarCo declares and distributes a 20% stock dividend on 5 million common

shares. Par value is $1 and market value is $20. Prepare the required journal entry.

18-69

Stock Splits

Decrease par value of stock.

Increase number of outstanding shares.

No change in total stockholders’ equity.

Does not require a journal entry.

Ice Cream Parlor

Banana Splits On Sale Now

18-70

Accounting for Stock Splits

A corporation had 5,000 shares of$1 par value common stock outstanding

before a 2–for–1 stock split.



Before Split

After Split

Common Stock Shares 5,000

Par Value per Share 1.00$

Total Par Value 5,000$

18-71

Accounting for Stock Splits

Increase

Decrease

No Change

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$





18-72Stock Splits Effected in theForm of Large Stock Dividends

Matrix, Inc. declares and distributes a 2-for-1 stock split effected in the form of a 100% stock dividend. The company has 1,000,000, $1 par value common stock outstanding. The stock is trading in the open market for $14 per share. The per share par value

of the shares is not to be changed.

Matrix, Inc. declares and distributes a 2-for-1 stock split effected in the form of a 100% stock dividend. The company has 1,000,000, $1 par value common stock outstanding. The stock is trading in the open market for $14 per share. The per share par value

of the shares is not to be changed.

18-73

Matrix, Inc. declares and distributes a 2-for-1 stock split effected in the form of a 100% stock dividend. The company has 1,000,000, $1 par value common stock outstanding. The stock is trading in the open

market for $14 per share. The per share par value of the shares is not to be changed and the company will

capitalize retained earnings.

Matrix, Inc. declares and distributes a 2-for-1 stock split effected in the form of a 100% stock dividend. The company has 1,000,000, $1 par value common stock outstanding. The stock is trading in the open

market for $14 per share. The per share par value of the shares is not to be changed and the company will

capitalize retained earnings.

Stock Splits Effected in theForm of Large Stock Dividends

18-74

Appendix 18

Quasi Reorganizations

18-75


Purpose

To allow a company undergoing financial difficulty, but with favorable future

prospects, to get a fresh start by writing down inflated assets and eliminating an

accumulated balance in retained earnings.

Purpose

To allow a company undergoing financial difficulty, but with favorable future

prospects, to get a fresh start by writing down inflated assets and eliminating an

accumulated balance in retained earnings.

18-76

Procedures

The firm’s assets and liabilities are revalued to reflect market values, with corresponding debits and credits to retained earnings.

The debit balance in retained earnings is eliminated first against additional paid in capital, and then, if necessary, against common stock.

Retained earnings is dated to indicate when the new accumulation of earnings began.

Procedures

The firm’s assets and liabilities are revalued to reflect market values, with corresponding debits and credits to retained earnings.

The debit balance in retained earnings is eliminated first against additional paid in capital, and then, if necessary, against common stock.

Retained earnings is dated to indicate when the new accumulation of earnings began.


18-77

Emerson-Walsch Corporation has incurredlosses for several years. The board

of directors voted to implement a quasi reorganization, subject

to shareholder approval.

The balance sheet prior to restatement, in millions, follows :

Emerson-Walsch Corporation has incurredlosses for several years. The board

of directors voted to implement a quasi reorganization, subject

to shareholder approval.

The balance sheet prior to restatement, in millions, follows :


18-78

(millions)Cash 75$ Receivables 200 Inventory 375 Property, plant, and equipment (net) 400 Total assets 1,050$

Liabilities 400$ Common stock (800 million shares @$1) 800 Additional paid-in capital 150 Retained earnings (deficit) (300) Total liabilities and equity 1,050$

Let’s prepare the journal entriesnecessary for the quasi reorganization.

Let’s prepare the journal entriesnecessary for the quasi reorganization.


Fair value of the inventory is $300,000,000 and fair valueof the property, plant, and equipment is $225,000,000.

18-79



Retained Earnings 250

Inventory 75

Property, plant, & equipment 175

To revalue assets.


18-80



Additional paid-in capital 150

Common stock 400

Retained earnings 550

To eliminate the deficit in retained earnings

Now, let’s prepare the balance sheetimmediately after restatement.

Now, let’s prepare the balance sheetimmediately after restatement.


$300 + $250

18-81

Cash 75$ Receivables 200 Inventory 300 Property, plant, and equipment (net) 225 Total assets 800$

Liabilities 400$ Common stock (800 million shares @$.50) 400 Additional paid-in capital 0Retained earnings 0 Total liabilities and equity 800$


18-82

End of Chapter 18

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