Preferred shareholders have rights not shared by common shareholders.
Receipt of dividends – confers the right, if dividends are declared by the corporation’s board of directors
Cumulative preferred stock means that missed dividends must be paid at a later date (dividends in arrears)
Claims on assets in case of liquidation – higher priority than the claim carried by the common stock
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2Chapter 12:Shareholders’ Equity3Learning Objective 1List the three forms of financing and distinguish debt from equity.4Shareholders’ Equity How to Finance a Corporation:Borrow (focus of chapter 11)Notes, Bonds, LeasesThe debt holders are legally entitled to repayment of their principal and interest claimsIssue EquityCommon and Preferred StockThe shareholders, as owners, have voting rights, limited liability, and a residual interest in the corporate assetsContributed capitalRetained Earnings (profitable operations)Earned capital5The Relative Importance of Liabilities, Contributed Capital, and Earned CapitalFigure 12-2 The relative importance of liabilities, contributed capital, and retained earnings (percentage of total assets)6Debt and Equity Distinguished – Characteristics 1. Formal legal contract 1. No legal contract 2. Fixed maturity date 2. No fixed maturity date 3. Fixed periodic payments 3. Discretionary dividend 4. Security in case of default payments 5. No direct voice in 4. Residual asset interest management – influence 5. Vote for board of directors through debt covenants 6. Dividends are not an expense 6. Interest is an expense but a distribution of retained earnings Debt Equity7Distinctions Between Debt and EquityInterested Party Debt Equity______ Investors / CreditorsLower investment riskHigher investment riskContractual future cash paymentsDividends are discretionaryEffects on credit ratingEffects of dilution/ takeoverInterest is tax deductibleDividends are not tax deductibleLiabilities section of the balance sheetShareholders’ equity of the balance sheetIncome statement effects from debtNo income statement effects from equityFixed cash receiptsVariable cash receiptsManagementAccountants/Auditors8Concept Practice 1 9Learning Objective 2Define and distinguish contributed capital from earned capital.10Accounting for Shareholders’ EquityThe Shareholders’ equity section of a corporate balance sheet consists of two major components.Contributed Capital Contributions from shareholdersPreferred stockCommon stockAdditional paid-in capitalTreasury stock (decrease)Earned CapitalAssets earned and retained by the corporationRetained earningsAccumulated comprehensive income11Accounting for Shareholders’ EquityKey business ratios rely on Shareholders’ equity which affects credit ratings and analysts evaluation of a companyFigure 12-5 Shareholders’ equity section of balance sheet12Concept Practice 2 13Learning Objective 3Define and distinguish preferred stock from common stock.14Preferred StockPreferred shareholders have rights not shared by common shareholders.Receipt of dividends – confers the right, if dividends are declared by the corporation’s board of directorsCumulative preferred stock means that missed dividends must be paid at a later date (dividends in arrears)Claims on assets in case of liquidation – higher priority than the claim carried by the common stock 15Common StockCommon stock is typically not characterized by a wide variety of features that differ from issuance to issuanceThe right to profits and to receive dividends if they are declared by the board of directorsResidual right to the corporation’s assets in case of liquidationThe right to exert control over management which includes the right to vote in the annual election of the board of directors 16Common StockMarket value – exchange price in open markets (this applies for common and preferred stock)Book value – The book value of the corporation (less preferred capital) as indicated on the balance sheetMarket-to-book ratio – Divide the market value of a company’s common stock by its book value. This indicates the extent to which the market believes the balance sheet reflects a company’s true value. Par value – Has little economic significance though it does affect journal entries and the balance in the stock (common or preferred) and paid in capital accounts17Preferred StockCommon StockAdvantagesPreference over common in liquidationVoting RightsStated dividendRights to residual profits (after preferred)Preference over common in dividend payoutDisadvantagesSubordinate to debt in liquidationLast in liquidationStated dividend can be skippedNo guaranteed returnNo voting rights (versus common)Debt or Equity?Components of bothEquityUsually classified as equityPreferred Stock vs. Common Stock18Accounting for Common and Preferred Stock IssuancesApple Computer Inc. issued 4.98 million shares of no-par common stock for an average price of $17.592 per share (total cash of $87.61 million) Cash (4.98 million x $17.592) 87.61 Common Stock 87.61Coca – Cola Enterprises issued 71.4 million shares of $1 par value common stock for $15.62 per share (total cash of $1,115.27) Cash (71.4 million x $15.62) 1,115.27 Common Stock (71.4 x $1 par) 71.40 APIC* - CS 1,043.87Weyerhaeuser Company issued 147,000 shares of $1 par value preferred stock for $11 per share Cash (147,000 x $11) 1,617,000 Preferred Stock (71.4 x $1 par) 147,000 APIC* - PS 1,470,000APIC – Additional Paid-in Capital19Simon Corp’s $1 par value, common stock was selling for $20 per share. Simon Corp’s owners’ equity accounts were as follows: Common stock $800,000 Additional paid-in capital 200,000 Retained earnings 400,000How many shares of common stock are outstanding?a. 30,000b. 600,000c. 800,000d. Not enough information to determine.20Learning Objective 4Define treasury stock, explain why companies acquire it, and describe how it is accounted for.21Treasury StockCreated when a company buys back shares of its own common stock.Reasons for buyback are numerous and includeMaintain leverage Support compensation plans Fend off takeover attemptsIncreasing stock priceRaise EPS Return money to shareholders22Treasury StockThe debit balance account called “Treasury Stock” is reported in shareholders’ equity as a contra account to Stockholders’ Equity. The stock remains issued, but is no longer outstanding.does not have voting rightscannot receive cash dividendsMay be reissued (to the market or to employees) or retired.No gains or losses are ever recognized from these equity transactions.23Purchasing Treasury StockMcDonald’s purchased treasury stock for a total cost of $3.2 billion – the following journal entry is recorded (dollars in billions)Treasury Stock 3.2 Cash 3.2This transaction brought the total investment in treasury shares held to McDonald’s to over $35 billion24Treasury Stock - Example ProblemTiger Corporation has 100,000 shares of $1 par value stock authorized, issued and outstanding at January 1, 2016. The stock had been issued at an average market price of $5 per share, and there have been no treasury stock transactions to this point. Assume that, in February of 2016, Tiger Corp. repurchases 10,000 shares of its own stock at $7 per share. In July of 2016, Tiger Corp. reissues 2,000 shares of the treasury stock for $8 per share. In December of 2016, Tiger Corp. reissues the remaining 8,000 shares for $6 per share. Prepare the journal entries for 2016 regarding the treasury stock. 25Treasury Stock Example - Journal EntriesFeb: repurchase 10,000 sh. @ $7 = $70,000. July: reissue 2,000 sh. @ $ 8 = $16,000 (cost = 2,000sh. @ $7 = 14,000) Treasury Stock 70,000 Cash 70,000Cash 16,000 Treasury Stock 14,000 APIC – Treasury Stock 2,00026Treasury Stock Example -Journal EntriesDec: reissue 8,000 sh. @ $ 6 = $48,000 (cost = 8,000 sh.@ $7 = 56,000)Now we need to debit one or more accounts to compensate for the difference. (1) debit APIC -TS (but lower limit is to -0-).(2) debit RE if necessary for any remaining balance (this is only necessary when we are decreasing equity).Cash 48,000 APIC – Treasury Stock (1) 2,000Retained Earnings (2) 6,000 Treasury Stock 56,00027Treasury stock isa. an asset representing a corporate investment in itself.b. highly-valued stock owned by a corporation.c. illegal for U.S. corporations.d. a decrease of shareholders’ equity.28Dividends are not paid ona. noncumulative preferred stock.b. nonparticipating preferred stock.c. treasury common stock.d. outstanding common shares.29Learning Objective 5Define a stock option, and describe how it is used and accounted for when compensating employees.30Stock OptionsGive employees (typically executives) the right to purchase company stock at a given price for a period of time.The idea is that if the stock price rises the executives purchase stock at a price less than its market value thereby getting a benefit.Since value is given up in the lower than market stock price and existing stockholders give up a percentage of ownership, GAAP requires that an expense be booked when the options are granted31Concept Practice 5 Dollars in millions32Learning Objective 6Define and distinguish cash dividends, stock dividends, and stock splits.33Retained Earnings Two factors that affect the retained earnings balanceDividendsAppropriationsDividends are distributions ofCashPropertyStockDeclared by formal resolution of the corporation’s board of directors34Retained Earnings Three dates are relevant when dividends are declaredDate of DeclarationBoard of directors declares dividend and liability is establishedDate of RecordShareholders holding stock at this date receive the dividend when paidDate of PaymentDividend is paid to shareholders of record35Accounting for Cash DividendsWhen the board of directors declares a dividend, a liability must be recognized.Marriot Corporation declared a fourth quarter cash dividend of $0.20 per share on 118.8 million common shares outstanding (dollars in millions)Cash Dividends (118.8 million sh. X $0.20/sh.) 23.76 Dividend Payable 23.76No journal entry is made on the date of recordOn the date of payment, the following entry is madeDividend Payable 23.76 Cash 23.76 36Retained Earnings We will be expanding the basic retained earnings formula in this chapter. Now the Statement of Retained Earnings will include the following: RE, beginning (unadjusted) xx Add/Subtract: Prior period adjustment xx RE, beginning (restated) xx Add: net income xx Less dividends: Cash dividends-common xx Cash dividends - preferred xx Stock dividends xx Property dividends xx Less: Adjustment for TS transactions xx Appropriation of RE xx RE, ending xx37Stock Splits and Stock Dividends There is little difference between stock splits and stock dividends for practical purposesFor example a 100 percent stock dividend and a 2:1 stock split double the number of outstanding shares.Ordinary stock dividends are less than 25 percent – otherwise they are considered stock splits in the form of dividends.38Stock SplitsIZM Company has 100,000 shares of $2 par value stock authorized, 10,000 shares issued and outstanding. The SE section of the balance sheet shows: Common stock $20,000Retained earnings 80,000 The market price of the outstanding shares is $50 per share before the split is distributed.39Example of Stock SplitIf IZM declared a 2 for 1 stock split, the old shares would be turned in and new shares would be issued with the following description:Common stock, $1 par value, 200,000 shares authorized, 20,000 shares issued and outstanding. The total Stockholders’ Equity is still $100,000: Common stock $20,000Retained earnings 80,000The market price per outstanding share would now be $25 per share.Note: No journal entry is necessary.40Stock Dividends vs Stock Splits Going back to the original IZM information. Assume instead that IZM declared a 4% stock dividend.Prepare the Journal Entry to record the declaration and distribution of the stock dividend for new shares {10,000 shares x 4% = 400 new shares x $50 per share = $20,000. This will be split between Common Stock (400X $2 par = 800) and APIC}:Stock Dividends (RE) 20,000 Common Stock 800 APIC – Common Stock 19,200 This journal entry moves dollars from retained earnings into Common Stock and Additional Paid-In Capital.41Stock Dividends vs Stock Splits Note the new description for the stock dividend:Common stock, $2 par value, 100,000 shares authorized, 10,400 shares issued and outstanding The total value in Shareholders’ Equity is still $100,000:Common Stock $40,000Retained Earnings 60,000$20,000 has been moved from RE to Common Stock & APICNote that the total market price per share would change to approximately $48.08 per share {(10,000X$50)/10,400 shares}.Total shareholders’ equity is the same for the stock split or the stock dividend.42Stock Dividends vs Stock Splits To summarize the effects on IZM Company: 4% Stock 2 for 1After: Dividend Stock SplitTotal sh. outstanding 10,400 sh. 20,000 sh.Par value per share $2 $1Market price per share $48.08 $25Total shareholders’ eq: $100,000 $100,000General ledger results: CS & APIC accounts $ 40,000 $ 20,000 RE account $ 60,000 $ 80,000Common Stock (CS) was $20,000 and Retained Earnings (RE) was $80,000 before the split or dividend. The stock dividend required journal entries, and the amounts for CS, APIC and RE changed. The stock split does not require a journal entry and the amounts for CS and RE do not change.43Why do Companies Declare Stock Dividends and Stock Splits?Note -Stock splits and stock dividends do not distribute additional assets to shareholdersProportionate ownership of the company is the same before and after a stock split or stock dividendReduce the per-share price of outstanding shares to make them easier to purchaseSignal of ‘good news’ from the company meaning that it may spark interest in the stock 44Comprehensive Class Problem - Shareholders’ EquityGiven the following SE balances for Company G at 1/1/17:Common stock, $10 par, 50,000 shares authorized, 20,000 shares issued and outstanding $200,000APIC on common stock 400,000Retained earnings 400,000During 2017, Company G had the following activity:1.Net income for the year was $250,000.2.Cash dividends of $2 per share were declared and paid on February 1.3.On June 1, Company G repurchased 2,000 shares of its own stock at $20 per share (using the cost method).4.On December 1, Company G reissued 500 shares of treasury stock at $18 per share.5.On December 15, Company G declared a 100% stock dividend, to be distributed to all of its shareholders (including treasury), on Jan. 15, 2018.45Comprehensive Class Problem - Shareholders’ Equity (continued)Required:A. Prepare journal entries for items 2 through 5 (item 1 would require detailed information for revenues and expenses to prepare - just know that the credit is to retained earnings for $250,000).B. the Statement of Stockholders’ Equity for Company G for 2017.C. Prepare the stockholders’ equity section of the balance sheet for Company G for 2017, including the appropriate description for the common stock.46Comprehensive Class Problem - SolutionA. Journal entries1. No entry required.2. Calc: 20,000 x $2 = 40,000 3.Calc: 2,000 shares x $20 = $40,000 Cash Dividends (RE) 40,000 Dividends Payable 40,000 Dividends Payable 40,000 Cash 40,000Treasury Stock 40,000 Cash 40,000 47Comprehensive Class Problem - SolutionPart A: Journal Entries4. Calc: 500 shares x $18 market = $9,000 500 shares x $20 cost = $10,000 5. Calc: 20,000 new shares x $10 par = $200,000 Note: in Item 5, the stock has not yet been distributed, so we cannot credit common stock, or show it issued yet. This “Stock Dividends Distributable” account is a related equity account, and indicates that there are shares of stock to be distributed in the future. Cash 9,000 marketRetained Earnings 1,000 Treasury Stock 10,000 costStock Dividend (RE) 200,000 Stock Div. Distributable 200,00048Comprehensive Class Problem - SolutionPart B: Statement of SE (in thousands) CS CSDD APIC RE TS Balance 1/1/17 $200 $400 $400Net income 250Cash dividends (40)Stock dividends $200 (200)Purchase of TS $(40)Reissue of TS ( 1) 10Balance, 12/31/17 $200 $200 $400 $409 $(30)Note: CSDD is Common Stock Dividends Distributable. When shares are distributed, then CS is increased.49Comprehensive Class Problem - SolutionPart C: Shareholders’ Equity Section of B/SCommon stock, $10 par value, 50,000 shares authorized, 20,000 shares issued,18,500 shares outstanding $ 200,000Common stock dividends distributable, 20,000 shares 200,000Additional paid-in capital, common stock 400,000Retained earnings 409,000Less: Treasury stock, 1,500 shares at cost (30,000)Total shareholders’ equity $1,179,000 50Learning Objective 7Interpret the information on a statement of shareholders’ equity, and discuss the rise of international equity markets.51The Statement of Shareholders’ EquityGAAP requires changes during the period in dollar values of separate accounts comprising the shareholders’ equity section be disclosed in the financial report.52International Perspective: The Rise of International Equity MarketsU.S. companies have found it increasingly important to raise money in international equity markets. International companies have previously found it challenging to enter U.S. equity markets due to differing accounting requirements, but U.S. exchanges now accept IFRS financial reports.Accountants must provide the financial reports necessary to support this investment activity.
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