Financial accounting the impact on decision makers 9e chapter 11

Chapter 11
Stockholders’ Equity


Stockholders’ Equity


Stockholders:
 Owners

of a corporation
 Have a residual interest in assets after liabilities are
satisfied


Stockholders’ equity:

Two major components
 Contributed capital
 Retained earnings

LO 1


Stockholders’ Equity


Contributed Capital:
 Amount

a corporation receives from the sale of

stock (common or preferred) to the stockholders
 Additional Paid-In Capital : amount received at
issuance that exceeds the par value of the stock


Retained earnings:
 Amount

of net income, over the life of the company
not paid out as dividends
 An important link between the income statement
and the balance sheet


EXHIBIT 11.1—Advantages and Disadvantages of
Stock versus Debt Financing


Stockholders’ Equity on the Balance
Sheet


The basic accounting equation:

Assets = Liabilities + Stockholders’ Equity


Two major components or subcategories:

Components of the Stockholders’
Equity Section of the Balance Sheet


Number of Shares



Par Value



Additional Paid-In Capital



Retained Earnings


Contributed Capital


Common stock
 Carries

voting rights
 The common stockholders elect the corporation’s
officers
• Establish its bylaws and governing rules


Preferred stock
 Flexible

and tailored to a company’s needs
 Preference in dividends


Number of Shares


Authorized shares: the maximum number of shares a corporation may
issue as indicated in the corporate charter



Issued shares: the number of shares sold or distributed to
stockholders



Outstanding shares: the number of shares issued less the number of
shares held as treasury stock


Par Value


An arbitrary amount that represents the legal capital of the firm



Stated on the face of the stock certificate



Also called “stated value”



Amount presented in the stock account


Additional Paid-In Capital & Retained
Earnings


Additional paid-in capital: the amount received for the issuance of
stock in excess of the par value of the stock



Retained earnings: net income that has been made by the corporation
but not paid out as dividends
 Not

necessarily available to stockholders
 May be used for purchase of assets, the retirement of
debt, or other financial needs

Exhibit 11.2—Retained Earnings Connects
the Income Statement and the Balance Sheet


IFRS and Stockholders’ Equity


Items that have characteristics of both debt and
equity




International accounting rules




Example: Convertible bond is similar to debt but
because it will become stock if converted, it also has the
characteristics of equity
An item having both debt and equity component should
be separated into two parts—liability and stockholders’
equity

U.S. accounting standards

Do not require to be recorded as a separate amount
 Recorded as either liability or stockholders’ equity




Preferred Stock


Flexible and tailored to a company’s needs



Dividends must be distributed to preferred stockholders before
common stockholders



Right to the company’s assets before the common stockholders during
liquidation



The dividend rate may be stated in two ways:
 Percentage

of the stock’s par value
 Per-share amount

LO 2


Preferred Stock Additional Terms and

Features


Convertible: allows preferred stock to be exchanged for common stock



Redeemable: allows stockholders to sell stock back to the company



Callable: allows the firm to eliminate a class of stock by paying the
stockholders a specified amount


Preferred Stock Additional Terms and
Features


Cumulative: the right to dividends in arrears before the current-year
dividend is distributed



Participating: allows preferred stockholders to share on a percentage
basis in the distribution of an abnormally large dividend


Issuance of Stock


Issued for cash or for noncash assets



When issued for cash:
 Par

value reported in the stock account
 Amount in excess of par is reported in the Paid-In
Capital account


When exchanged for noncash items:
 Recorded

at the fair market value of the stock or the
assets received, whichever is most readily
determined
LO 3


Example 11.1—Recording Stock
Issued for Cash


Assume that on July 1, a firm issued 1,000 shares of $10 par common
stock for $15 per share

Example 11.2—Recording Stock for
Noncash Consideration


Assume that on July 1, a firm issued 500 shares of $10 par
preferred stock to acquire a building. The stock is not widely
traded, and the current market value of the stock is not evident.
The building has recently been appraised by an independent
firm as having a market value of $12,000


Treasury Stock


Represents the corporation’s own stock, previously issued to
shareholders, repurchased from stockholders and not retired,
but held for various purposes



Repurchase is recorded as a debit to Treasury Stock, a contraequity account



For an amount to be treated as treasury stock:


It must be the corporation’s own stock



It must have been issued to the stockholders at some point



It must have been repurchased from the stockholders



It must not be retired, but must be held for some purpose
LO 4


Example 11.3—Recording the Purchase
of Treasury Stock


Assume that the Stockholders’ Equity section of Rezin Company’s
balance sheet on December 31, 2014, appears as follows:


Example 11.3—Recording the Purchase
of Treasury Stock (continued)


Assume that on February 1, 2015, Rezin buys 100 of its shares as
treasury stock at $25 per share.


Stockholders’ Equity Section



The Stockholders’ Equity section of Rezin’s balance sheet on February
1, 2015, after the purchase of the treasury stock


Retirement of Stock


Repurchase of stock with no intention of reissuing



To eliminate a particular class of stock or group of stockholders



The general principle for retirement of stock is the same as for treasury
stock transactions



No income statement accounts are affected



Effect is reflected in the Cash account and the Stockholders’ Equity
accounts

Cash Dividends


Declared only if a company has sufficient cash available and adequate
retained earnings



Not an expense on the income statement



Date of declaration: cash dividends are declared



Payment date: cash dividends are paid



Date of record: dividend is paid to the stockholders who own the stock
as of this date

LO 5


Dividend Payout Ratio


The annual dividend amount divided by the annual net income



RatioDividend
for many firms
is 50%Ratio
or 60%= and seldom exceeds 70%
Payout

Annual Dividend
Annual Net Income