Copyright © 2012 The McGraw-Hill Companies, Inc.
PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA
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 IncorporationAdvantages of Incorporation
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 IncorporationDisadvantages of Incorporation
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
Stockholders
Functions of the Board of DirectorsFunctions of the Board of Directors
Primary functions are to set corporate policies ad protect stockholders.
11-9
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 OfficersFunctions of the Corporate Officers
11-10
Publicly Owned Corporations Face Publicly Owned Corporations Face Different RulesDifferent 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.
11-11
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.
11-12
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 CorporationStockholders’ Equity of a Corporation
11-13
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
11-14
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
Authorization and IssuanceAuthorization and Issuanceof Capital Stockof Capital Stock
11-15
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
Authorization and IssuanceAuthorization and Issuanceof Capital Stockof Capital Stock
11-16
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
11-17
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.
11-18
Assume a corporation issues 10,000 shares of its $2 par value stock for $25 per share.
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
11-19
Issuance of Par Value StockIssuance of Par Value Stock
Assume a corporation issues 10,000 shares of its $2 par value stock for $25 per share.
Assume a corporation issues 10,000 shares of its $2 par value stock for $25 per share.
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
11-20
Issuance of Par Value StockIssuance of Par Value Stock
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
11-21
Common Stock and Preferred StockCommon Stock and Preferred Stock
Show below is the stockholders’ equity section of Martin, Inc. The company has both common and preferred stock outstanding.
Stockholders' equity:Preferred stock, 4% cumulative, $100 par value, authorized 50,000 shares, issued and outstanding 5,000 shares 500,000$ Common stock, $4 par value, authorized 3,000,000 shares, issued and outstanding 750,000 shares 3,000,000 Additional paid-in capital: Preferred stock 75,000 Common stock 10,500,000 Total paid-in capital 14,075,000 Retained earnings 1,922,500 Total stockholders' equity 15,997,500$
11-22
Preferred StockPreferred Stock
A 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:
11-23
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
11-24
Example: Consider the following partial Statement of Stockholders’ Equity.
During 2010, the directors declare cash dividends of $5,000. In 2011, the directors
declare cash dividends of $42,000.
Stock Preferred as to DividendsStock Preferred as to Dividends
11-25
Stock Preferred as to DividendsStock Preferred as to Dividends
Preferred CommonIf Preferred Stock is Noncumulative:Year 2010 $5,000 dividends declared 5,000$ -$
Year 2011 Step 1: Current preferred dividend 9,000$
Step 2: Remainder to common shareholders 33,000$
If Preferred Stock is Cumulative:Year 2010 $5,000 dividends declared 5,000$ -$
Year 2011 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$
11-26
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 StockOther Features of Preferred Stock
11-27
Preferred StockPreferred Stock
Stockholders' 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 - $10 par value; 50,000 shares authorized; 30,000 shares issued and outstanding 300,000 Additional Paid-in Capital 1,000 Retained Earnings 65,000 Total Stockholders' Equity 371,000$
11-28
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≠
11-29
Book Value With Both Preferred and Book Value With Both Preferred and Common StockCommon Stock
Davis company has paid no dividends in the current year. As of December 31st, dividends in arrears on cumulated preferred stock total $50,000. All equity belongs to common stockholders except the $500,000 applicable to preferred stock and the $50,000 dividends in arrears. Here is the calculation of book value for common stock:
Total stockholders' equity 1,950,000$ Less: Equity of preferred stockholders" Par value of preferred stock 500,000$ Dividends in arrears 50,000 550,000 Equity of common stockholders 1,400,000 Number of common shares outstanding 700,000 Book value per share of common stock 2.00$
11-30
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
11-31
Market Price of Preferred StockMarket Price of Preferred Stock
Factors affecting market price of preferred stock:
• Dividend rate• Risk• Level 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.”
11-32
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 StockMarket Price of Common Stock
11-33
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.
11-34
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$
11-35
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
11-36
Riley Corporation reacquires 3,000 of its common shares in the open market at $55
per share.Prepare the journal entry to record the
purchase of treasury stock.
Recording Purchases of Recording Purchases of Treasury StockTreasury Stock
Description Debit Credit
Treasury Stock 165,000 Cash 165,000 3,000 shares × $55 = $165,000
11-37
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
Description Debit Credit
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
11-38
Stockholders’ Equity PresentationStockholders’ Equity Presentation
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$
11-39
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.
11-40
Financial Analysis andFinancial Analysis andDecision MakingDecision Making
Return on CommonStockholders’ Equity
Net Income Average Common Stockholders’ Equity
=
11-41
End of Chapter 11End of Chapter 11