Financial Accounting:: Tools For Business Decision Making, 4th Ed

Financial Accounting:
Tools for Business Decision Making, 4th Ed.

Kimmel, Weygandt, Kieso
CHAPTER 11
Prepared by
Ellen L. Sweatt
Georgia Perimeter College
and
Barbara Muller
Arizona State University West
Chapter 11
REPORTING AND
ANALYZING
STOCKHOLDERS
EQUITY
Reporting and Analyzing

Stockholders Equity
After studying Chapter 11, you

should be able to:
Identify and discuss the major
characteristics of a corporation.
Record the issuance of common
stock.
Explain the accounting for the
purchase of treasury stock.
Differentiate preferred stock from
common stock.
Reporting and Analyzing

Stockholders Equity
Prepare the entries for cash

dividends and understand the effect
of stock dividends and stock splits.
Identify the items that affect
retained earnings.
Prepare a comprehensive
stockholders' equity section.
Evaluate a corporation's dividend
and earnings performance from a
stockholder's perspective.
4
Corporation
Created by law
Legal entity
Has most of the rights and
privileges of a person
Classified by purpose and
ownership
Purpose - profit or nonprofit
Ownership - publicly or privately
held
5
Publicly Held Corporation...

May have thousands of stockholders.
Its stock is regularly traded on national
securities markets.
Privately Held
Corporation...
Usually has only a few stockholders and
does not offer its stock for sale to general
public.
11
Characteristics of a
Corporation
Separate legal existence
Limited liability of stockholders
Transferable ownership rights
Ability to acquire capital
Continuous life
Corporation management
Government regulations
Additional taxes
7
Separate Legal Existence
Separate and distinct from

its owners.
Acts under its own name.
May buy, own, sell
property; borrow money;
enter into legally binding
contracts; may sue or be
sued; pays its own taxes.
Owners (stockholders)
cannot bind corporation
unless owners are agents
of the corporation.
Limited Liability of Stockholders
Creditors have recourse only

to corporate assets to satisfy
their claims.
Liability of stockholders
limited to their investment in
their corporation.
Creditors have no legal claim
on personal assets
of stockholders unless fraud
has occurred.
Stockholders losses limited to
amount of capital invested.
9
Transferable Ownership Rights
Ownership evidenced by shares of stock

Transfer of ownership among stockholder
has no effect on corporations operating
activities or assets,
liabilities and total
stockholders' equity.
Corporation does not
participate in transfer of
ownership rights
after original sale.
10
Ability to Acquire Capital

Limited liability of stockholders
coupled with transferable
ownership rights make it easy to
raise capital.
11
Continuous Life
Life of corporation is stated in its

charter - may be perpetual or limited to
specific number of years (can be
extended).
Corporation is separate
legal entity, thus life
not affected by
withdrawal, death,
or incapacity of a stockholder.
12
Corporation Management
The corporation establishes by-laws

upon receipt of its charter from the
state of incorporation.
Stockholders manage corporation
indirectly through board of
directors.
Board of directors
formulates operating policies
selects officers to execute policy and to
perform daily management functions.
13
Corporate Organization
Chart
15
Additional Taxes
16
Forming a Corporation
A corporation can operate in

various states (must have a
license from each state in
which it does business) but can
be incorporated in only one
state.
17
Stockholder Rights
Once chartered, the corporation

sells stock .
If only one class of stock - called
common stock.
Ownership rights specified in the
articles of incorporation or bylaws.
Proof of stock ownership is a
printed or engraved form known
as a stock certificate.
18
19
Stock Certificate Shows...

Name of the corporation
Stockholder's name
Class and special features of the
stock
The number of shares owned
The signatures of
duly authorized
corporate officials.
20
Questions in Issuing Stock...
How many shares should be

authorized for sale?
How should the stock be issued?
At what price should the shares

be issued?
22
Authorized
Maximum
amountStock...
of stock a
corporation is allowed to sell as
authorized by corporate charter.
Issued Stock...
Number of shares of issued stock

have been sold and been paid for.
Outstanding Stock...
Number of shares of issued stock

that are being held by stockholders.
23
Corporations Can Issue Stock
Directly to investors (typical in

privately held corporations).
Indirectly through an
investment banking firm
(customary with publicly held
corporations).
24
Par Value Stock...
Is capital stock that has been

assigned a value per share in the
corporate charter.
Legal capital per share must be

retained in the business for the
protection of corporate creditors.
25
No-Par Value Stock...
Capital stock that has not been

assigned a value per share in the
corporate charter.
Stated Value of No-Par

Stock
Amount per share assigned by the

board of directors to no-par stock.
Par Value and Stated Value have NO
relationship to market value.
26
Stockholders Equity Section of a

Corporations Balance Sheet
Two Parts:
Paid-in (contributed) capital - Amount paid to
corporation by stockholders in exchange for
shares of ownership.
Retained earnings (earned capital) Earned capital held for future use in the business.
27

Review
Whichofthefollowingrepresentsthe
maximumnumberofsharesacorporationcan
issue?
a. Outstandingshares
b. Issuedshares
c. AuthorizedShares
d. TreasuryShares
28

Review
Whichofthefollowingrepresentsthe
maximumnumberofsharesacorporationcan
issue?
a. Outstandingshares
b. Issuedshares
c. AuthorizedShares
d. TreasuryShares
29
Accounting for
Common Stock Issues
11
The issue of common stock affects

only paid-in capital accounts.
When the issuance of common
stock for cash is recorded, the par
value of the shares is credited to
common stock.
The portion of the proceeds above
or below par value is recorded in a
separate paid-in capital account.
30
Issuing Stock at Par

Hydro-Slide, Inc., issues 1,000 shares
of $1 par value of common stock at
par for cash.
Cash
Common Stock
1,000
1,000
31
Issuing Stock Above Par

If Hydro-Slide, Inc., issues an additional
1,000 shares of the $1 par value
common stock for cash at $5 per share,
the entry is:
Cash
5,000
Common Stock
1,000
Paid-in Capital in
Excess of Par Value
4,000
32
Hydro-Slide, Inc.
Balance Sheet (partial)
Stockholders' equity
Paid-in capital
Common stock
Paid-in capital in excess of par
Total paid-in capital
Retained earnings
Total stockholders' equity
$ 2,000
4,000
$ 6,000
27,000
$33,000
Mead, Inc.
Paid-in capital
Common stock,$5par value,
100,000 shares issued and
outstanding
Retained Earnings
Total stockholders equity
700,000
$ 500,000
200,000
$
BEFORE TREASURY STOCK TRANSACTION
11
Treasury Stock...
Is a corporation's own stock

that has been issued
fully paid for
reacquired by the corporation
held in its treasury for future use .
35
Corporations Acquire Treasury

Stock to...
Reissue shares to officers and employees

under bonus and stock compensation
plans.
Increase trading of company's stock in
securities market in hopes of enhancing
market value.
Have additional shares available for use
in acquisition of other companies.
Reduce number of shares outstanding
thereby increasing earnings per share.
36
Prevent a hostile takeover.
Purchase of Treasury Stock

On February 1, 2007, Mead
acquires
4,000 shares of its
stock at $8 per share.
Treasury Stock
Cash
32,000
32,000
37
Treasury Stock
The Treasury Stock account would increase

by the cost of the shares purchased $32,000.
The original paid-in capital account,
Common Stock, would not be affected
because the number of issued shares does
not change.
Treasury stock is deducted from total paidin capital and retained earnings in the
stockholders' equity section of the balance
sheet.
38
Mead, Inc.
Paid-in capital
Common stock,$5par value,
100,000 shares issued and
96,000 outstanding
Retained Earnings
700,000
Less: Treasury Stock
32,000
$ 500,000
200,000
$ 668,000
AFTER TREASURY STOCK TRANSACTION
Review
Inthestockholdersequitysection,thecost
oftreasurystockisdeductedfrom:
a. totalpaid-incapitalandretainedearnings
b. retainedearnings
c. totalstockholdersequity
d. commonstockinpaid-in-capital
40
Review
Inthestockholdersequitysection,thecost
oftreasurystockisdeductedfrom:
a. totalpaid-incapitalandretainedearnings
b. retainedearnings
c. totalstockholdersequity
d. commonstockinpaid-in-capital
41
Preferred Stock...
11
Capital stock that has

contractual preferences over
common stock in certain areas.
Dividends
Assets in the event of liquidation
Preferred stockholders do not have

voting rights.
42
Preferred Stock
Assume Corporation issues 10,000 shares of

$10 par value preferred stock for $12 cash
per share.
Cash
120,000
Preferred Stock
100,000
Paid-in Capital in Excess
20,000
of Par Value--Preferred Stock
(Preferred stock may have either a par value or
no-par value.)
43
Dividend Preferences
Preferred stockholders have the right

to share in the distribution of
corporate income before common
stockholders.
The first claim to dividends does not
guarantee dividends.
44
Cumulative Dividend...
Is a feature of preferred stock
entitling the stockholder to receive
current and unpaid prior-year
dividends before common
stockholders receive any dividends.
45
Dividends in Arrears...
Are preferred dividends that

were scheduled to be declared
but were not declared during a
given period.
Are not a liability. No
obligation exists until a
dividend is declared by the
board of directors.
Must be disclosed in the notes
to the financial statements.
46
Dividends in Arrears
Scientific-Leasing has 5,000 shares of 7%, $100
par value cumulative preferred stock
outstanding.
The annual dividend is $35,000 (5,000 x $7 per
share).
Dividends are 2 years in arrears
Dividends in arrears ($35,000 x 2 years)
Current-year dividends
Total preferred dividends
$105,000
$ 70,000
35,000
47
Liquidation Preference
Is a feature that gives
preferred stockholders
preference to corporate assets
in the event of liquidation.
48
11
Dividend...
Is a distribution by a corporation to
its stockholders on a pro rata basis.
Pro rata means that if you own 10%
of the common shares, you will
receive 10% of the dividend.
Dividend forms:
cash
property
script (promissory note to pay cash)
stock
49
Cash Dividend
Is a pro rata distribution of cash

to stockholders.
A corporation must have 3
things to pay cash dividends:
Retained earnings
Adequate cash
Declared dividends
50
Cash Dividend
In many states, payment of dividends

from legal capital is prohibited.
Payment of dividends from paid-in
capital in excess of par is legal in
some states.
Payment of dividends from retained
earnings is legal in all states.
Companies are frequently
constrained by agreements with
lenders to pay dividends only from
retained earnings.
51
Entries for Cash Dividends
Three dates are important

in connection with
dividends:
the declaration date
the record date
the payment date Montha ndye a r
Monday
Tue sday
Wedne sday
Thursday
Friday
Saturday
Sunday
00
00
00
00
00
00
00
00
00
00
00
00
00
00
00
00
00
00
00
00
00
00
00
00
00
00
00
00
00
00
00
00
00
00
00
52
The Declaration Date...
Is the date the board of directors

declares the cash dividend.
Commits the corporation to a binding
legal obligation that cannot be
On December
1, 2007, the directors of Media
rescinded.
General declare a $.50 per share cash dividend
on 100,000 shares of $10 par value common
stock.
The dividend is $50,000 (100,000 x $.50).
12/1
Retained Earnings
Dividends Payable
50,000
50,000
53
The Record Date...

The date ownership of the outstanding shares is
determined for dividend purposes.
Dec 20
No Entry Necessary.
The Payment Date...

The date dividend checks are mailed.
January 20 is the payment date for Media
General.
Jan 20 Dividends Payable
Cash
50,000
50,000
54
A Stock Dividend...
Is a pro rata distribution of the

corporation's own stock to stockholders.
Is paid in stock.
Results in a decrease in retained
earnings and an increase in paid-in
capital.
Does not decrease total stockholders'
equity or total assets.
Is often issued by companies that do not
have adequate cash to issue a cash
dividend.
55
Stock Dividends
You have a 2% ownership interest in

Cetus Inc., owning 20 of its 1,000
shares of common stock.
In a 10% stock dividend, 100 shares
(1,000 x 10%) of stock would be
issued. You would receive two shares
(2% x 100), but your ownership
interest would remain at 2% (22 /
1,100).
You now own more shares of stock, but
your ownership interest has not
changed.
56
Reasons for Stock

Dividends
To satisfy stockholders' dividend

expectations without spending cash.
To increase marketability of its stock
by increasing number of shares
outstanding and decreasing market
price per share.
To emphasize that a portion of
stockholders' equity has been
permanently reinvested in business
and is unavailable for cash dividends.
57
Stock Dividends
A small stock dividend (less than

20%-25% of the corporation's
issued stock) is recorded at the
fair market value per share.
A large stock dividend (greater
than 20%-25% of the corporation's
issued stock) is recorded at par or
stated value per share.
58
Stock Split
Because a stock split does not
affect the balances in
stockholders' equity accounts, it
is not necessary to journalize a
stock split.
59
Stock Split...
Is the issuance of additional shares of

stock to stockholders accompanied by:
A reduction in the par or stated value.
An increase in number of shares.
A stock split does not have any effect
on total paid-in capital, retained
earnings, and total stockholders' equity.
60
Review
Vista,Inc.had300,000sharesofcommonstockoutstanding
whena30%stockdividendwasdeclaredandissued.Howmany
shareswereoutstandingafterthestockdividend?
a. 390,000
b. 330,000
c. 300,000
d. 309,000
61
Review
Vista,Inc.had300,000sharesofcommonstockoutstanding
whena30%stockdividendwasdeclaredandissued.Howmany
shareswereoutstandingafterthestockdividend?
a. 390,000
b. 330,000
c. 300,000
d. 309,000
62
11
Retained
Earnings...
Is net income that is retained in
the business.
The balance in retained earnings
is part of the stockholders' claim
on the total assets of the
corporation.
Retained earnings does not
represent a claim on any specific
asset.
63
Deficit
Is a debit balance in retained
earnings and is reported as a
deduction in the stockholders'
equity section of the balance
sheet.
64
Retained Earnings
Restrictions...
Are legal, contractual or
voluntary circumstances that
make a portion of retained
earnings currently unavailable
for dividends.
65
Stockholders Equity with

Deficit
66
11
The Payout Ratio =
CASH DIVIDENDS DECLARED ON COMMON STOCK

NET INCOME
measures the percentage of earnin

distributed in the form of cash dividend
to common stockholders.
69
Return on Common
Stockholders Equity Ratio =
NET INCOME - PREFERRED STOCK DIVIDENDS
AVERAGE COMMON STOCKHOLDERS EQUITY
...measures the profitability from

the stockholders point of view.
70
Advantages of Bond Financing

Over Common Stock
Relationship of Par and No-Par

Value to Legal Capital
Stock
Par value
Legal Capital Per

Share
Par value
No-par value with Stated value

stated value
No-par value
Entire proceeds
without stated
value
72
Stock Dividends
Medland Corporation has $300,000 in

retained earnings and declares a 10%
stock dividend on its 50,000 shares of
$10 par value common stock.
The current fair market value of the
stock is $15 per share.
Retained Earnings
75,000
Common Stock Dividends
50,000
Distributable
Paid-in Capital in Excess
25,000
73
of Par Value
Review
Rogerisnearingretirementandwouldliketoinvestinastock
thatwillprovideagoodsteadyincomesupply.Rogershould
chooseastockwitha:
a)highcurrentratio.
b)highdividendpayout.
c)highearningspershare.
d)highpriceearningsratio.
74
Review
Rogerisnearingretirementandwouldliketoinvestinastock
thatwillprovideagoodsteadyincomesupply.Rogershould
chooseastockwitha:
a)highcurrentratio.
b)highdividendpayout.
c)highearningspershare.
d)highpriceearningsratio.
75
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Copyright 2007, John Wiley & Sons, Inc. All rights reserved.
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Financial Accounting:

Tools for Business Decision Making, 4th Ed.

Reporting and Analyzing

After studying Chapter 11, you

Reporting and Analyzing

Prepare the entries for cash

Publicly Held Corporation...

Separate Legal Existence

Separate and distinct from

Limited Liability of Stockholders

Creditors have recourse only

Transferable Ownership Rights

Ownership evidenced by shares of stock

Ability to Acquire Capital

Life of corporation is stated in its

The corporation establishes by-laws

A corporation can operate in

Once chartered, the corporation

Stock Certificate Shows...

Questions in Issuing Stock...

How many shares should be

How should the stock be issued?

At what price should the shares

Number of shares of issued stock

Number of shares of issued stock

Corporations Can Issue Stock

Directly to investors (typical in

Par Value Stock...

Is capital stock that has been

Legal capital per share must be

No-Par Value Stock...

Capital stock that has not been

Stated Value of No-Par

Amount per share assigned by the

Stockholders Equity Section of a

The issue of common stock affects

Issuing Stock at Par

Issuing Stock Above Par

BEFORE TREASURY STOCK TRANSACTION

Is a corporation's own stock

Corporations Acquire Treasury

Reissue shares to officers and employees

Purchase of Treasury Stock

The Treasury Stock account would increase

AFTER TREASURY STOCK TRANSACTION

Capital stock that has

Preferred stockholders do not have

Assume Corporation issues 10,000 shares of

Preferred stockholders have the right

Are preferred dividends that

Is a pro rata distribution of cash

In many states, payment of dividends

Entries for Cash Dividends

Three dates are important

The Declaration Date...

Is the date the board of directors

The Record Date...

The Payment Date...

Is a pro rata distribution of the