Lecture Accounting: What the numbers mean (5/e) - Chapter 8: Accounting for and presentation of owner’ equity

CHAPTER 8
ACCOUNTING FOR AND
PRESENTATION OF
OWNER’ EQUITY

McGraw­Hill/Irwin

©The McGraw­Hill Companies, Inc., 2002


Learning Objectives
• What are the characteristics of common
stock, and how is common stock presented
in the balance sheet?
• What is preferred stock, what are its
advantages and disadvantages to the
corporation, and how is it presented on the
balance sheet?
• How are cash dividends accounted for, and
what are the dates involved in dividend
transactions?
McGraw­Hill/Irwin

©The McGraw­Hill Companies, Inc., 2002


Learning Objectives
• What are stock dividends and stock
splits, and why are they used?
• What are the components of “other
comprehensive income,” and why do

these items appear in owners’ equity?
• What is treasury stock, why is it
acquired, and how do treasury stock
transactions affect owners’ equity?
• How are owners’ equity transactions
for the year reported in the financial
statements?
McGraw­Hill/Irwin

©The McGraw­Hill Companies, Inc., 2002


Learning Objective 1
• What are the characteristics
of common stock, and how
is common stock presented
in the balance sheet?

McGraw­Hill/Irwin

©The McGraw­Hill Companies, Inc., 2002


Owners’ Equity
• The claim of the entity’s owners to the
assets shown in the balance sheet
• Also called net assets
• Owner’s equity for a individual
proprietorship is called proprietor’s capital
• Owners’ equity of a partnerships is called

partners’ capital
• Owners’ equity for a corporation consists
of paid-in capital and retained earnings
McGraw­Hill/Irwin

©The McGraw­Hill Companies, Inc., 2002


Paid-In Capital
• Referred to as contributed capital
• Consists of:
– Common stock
– Preferred stock
– Additional paid-in capital

McGraw­Hill/Irwin

©The McGraw­Hill Companies, Inc., 2002


Common Stock
• Also called capital stock
• The ultimate owners of the corporation
• Have claim to all assets after all
liabilities and preferred stock claims
have been satisfied
• Have the right and obligation to elect
members of the corporation’s board of
directors
McGraw­Hill/Irwin

©The McGraw­Hill Companies, Inc., 2002


Value of Common Stock
• Common stock can have par or no-par
• Par value is the nominal value assigned
to the stock when the corporation is
formed
• Usually a stock cannot be issued for a
value less than par
• Stated value stock is essentially the
same as par value
McGraw­Hill/Irwin

©The McGraw­Hill Companies, Inc., 2002


Recording Common Stock
• Par-value common stock sold above par is
recorded as follows:
Cash
Common stock
Additional paid-in capital

XX
XX
XX

• No-par common stock is recorded as follows:

Cash
Common stock
McGraw­Hill/Irwin

XX
XX
©The McGraw­Hill Companies, Inc., 2002


Common Stock Disclosures
• Authorized shares of stock represents the
maximum number of shares of stock the
corporation is legally approved to issue
• Issued shares represents the number of
shares of stock that have been transferred
from the corporation to shareholders
• Outstanding shares of stock represents
the shares of stock still in the hands of
shareholders
• Treasury stock represents the difference
between issued and outstanding shares
McGraw­Hill/Irwin

©The McGraw­Hill Companies, Inc., 2002


Learning Objective 2
• What is preferred stock, what are
its advantages and disadvantages
to the corporation, and how is it

presented on the balance sheet?

McGraw­Hill/Irwin

©The McGraw­Hill Companies, Inc., 2002


Preferred Stock
• Has several debt-like features and a
limited claim on the assets in the event
of liquidation
• Most preferred stock receives a
quarterly or semiannual dividend
• A dividend is a distribution of earnings
of a corporation to its owners
• The amount of the dividend is usually
stated as a dollar amount or as a
percentage (of par value)
McGraw­Hill/Irwin

©The McGraw­Hill Companies, Inc., 2002


Preferred Stock Dividends
• A cumulative dividend means that a missed
dividend must be paid before dividends are paid
to common shareholders
• A participating dividend means that after
common stockholders have received a specified
dividend, further dividends are shared by

common and preferred shareholders
• A liquidating dividend is the preferred stock
claim on assets in the event of liquidation
McGraw­Hill/Irwin

©The McGraw­Hill Companies, Inc., 2002


Types of Preferred Stock
• Callable preferred stock is redeemable at
the option of the corporation
• Convertible preferred stock may be
exchanged for common stock of the
corporation at the option of the shareholder
at a stated conversion rate

McGraw­Hill/Irwin

©The McGraw­Hill Companies, Inc., 2002


Additional Paid-In Capital
• The owners’ equity category that reflects
the excess of the amount received from
the sale of preferred or common stock
over par value
• Also referred to as capital in excess of
par value or capital surplus

McGraw­Hill/Irwin

©The McGraw­Hill Companies, Inc., 2002


Retained Earnings
• The retained earnings account reflects
the cumulative earnings of the
corporation that have been retained for
use in the business rather than paid out
as dividends
• Retained earnings are not cash
• The main factors affecting retained
earnings are net income (or loss) and
dividends
McGraw­Hill/Irwin

©The McGraw­Hill Companies, Inc., 2002


Learning Objective 3
• How are cash dividends accounted
for, and what are the dates involved
in dividend transactions?

McGraw­Hill/Irwin

©The McGraw­Hill Companies, Inc., 2002


Cash Dividends

• To pay a dividend, a corporation must have:
– Sufficient retained earnings
– Sufficient cash to pay the dividend
– A dividend declaration by the board of
directors
• The key dates related to dividends are:
– Date of declaration
– Date of record
– Date of payment
McGraw­Hill/Irwin

©The McGraw­Hill Companies, Inc., 2002


Dividend Dates
• Date of declaration is the date the board of
directors declares the dividend
• Date of record is the date used to determine
who receives the dividend – the stockholders
of record as of that date
• Date of payment is the date the dividend
checks are mailed to the shareholders
• Ex-dividend date is three business days
before the date of record – the stock trades
without the dividend
McGraw­Hill/Irwin

©The McGraw­Hill Companies, Inc., 2002

Learning Objective 4
• What are stock dividends and stock
splits, and why are they used?

McGraw­Hill/Irwin

©The McGraw­Hill Companies, Inc., 2002


Stock Dividends
• The issuance of additional stock to existing
shareholders in proportion to the number of
shares currently owned
• Used to maintain loyalty of stockholders
when the firm does not have enough cash
for a cash dividend
• Affects only owners’ equity of the firm:
Retained earnings
XX
Common stock
XX
Additional paid-in capital
XX
McGraw­Hill/Irwin

©The McGraw­Hill Companies, Inc., 2002


Stock Split
• Will lower the market price of a firm’s

stock
• Involves issuing additional share of
stock to existing shareholders
• No accounting entry is required
• The par value and the number of
shares issued changes
McGraw­Hill/Irwin

©The McGraw­Hill Companies, Inc., 2002


Learning Objective 6
• What is treasury stock, why is it
acquired, and how do treasury
stock transactions affect owners’
equity?

McGraw­Hill/Irwin

©The McGraw­Hill Companies, Inc., 2002


Treasury Stock
• Shares of a corporation’s own stock that
have been purchased from shareholders
• Is reflected on the balance sheet as a
contra owners’ equity account
• Treasure stock is not an asset
• Recorded as follows:
Treasury stock

Cash

McGraw­Hill/Irwin

XX
XX

©The McGraw­Hill Companies, Inc., 2002


Sales of Treasury Stock
• When sold above purchase price, treasury stock
transactions are recorded as follows:
Cash

XX

Treasury stock
Additional paid-in capital

XX
XX

• Cash dividends are not paid on treasury stock
since the firm would be paying itself a dividend
• Stock dividends and stock splits do affect
treasury stock
McGraw­Hill/Irwin

©The McGraw­Hill Companies, Inc., 2002