Stockholders Equity

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Learning Objective 1
Explain the advantages and disadvantages of a corporation.

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Characteristics of a Corporation
nSeparate legal entity nContinuous life and transferability

of ownership nLimited liability nSeparation of ownership and management nCorporate taxation nGovernment regulation
2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Advantages of a Corporation
1. Can raise more capital than a proprietorship or partnership can 2. Continuous life 3. Ease of transferring ownership 4. Limited liability of stockholders

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Disadvantages of a Corporation
1. Separation of ownership 2. Corporate taxation 3. Government regulation

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Authority Structure of a Corporation

Stockholders

Board of Directors

Chairperson of the Board

President
6

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Stockholders Rights
Vote Dividends Liquidation Preemption
7

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Stockholders Equity
Two main components: 1. Paid-in capital (contributed capital) 2. Retained earnings

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Capital Stock
nAuthorized shares nOutstanding shares

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Capital Stock
Ordinary Shares/ Common Stock Most basic form of capital stock issued by every corporation Preference Shares/ Preferred Stock Has several preferences over ordinary shares/ common stock
10

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Capital Stock
Par Value Stock No-par Stock

An arbitrary amount assigned to a share of stock

Does not have par value, but may have stated value
11

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Learning Objective 2
Measure the effect of issuing stock on a companys financial position.

12

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Ordinary Shares at Par

Suppose IHOPs ordinary shares has a par value of P10 per share. The company issues 6,200 shares of ordinary shares at par. What is the entry?
General Journal Date Accounts and Explanations PR Debit Credit

Jan 8

Cash (6,200 x $10) Ordinary share capital stock To record issuance of stock

62,000 62,000

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Ordinary Shares at above Par

Suppose IHOPs common stock has a par value of P0.01 per share. The company issues 6,200 shares of common stock for P10 per share. What is the entry?
Date General Journal Accounts and Explanations PR Debit Credit

Jul 23 Cash (6,200 x $10) Common Stock Paid-in Capital in Excess of Par To record issuance of stock
2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

62,000 62 61,938

Ordinary Shares at above Par

Stockholders Equity Ordinary shares, P.01 par; 40,000 shares authorized, 6,200 shares issued Paid-in capital in excess of par Total paid-in capital Retained earnings Total stockholders equity
2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

62 61,938 P 62,000 194,000 P256,000

Ordinary Shares at Par

Suppose IHOPs common stock is no par value stock. The company issues 6,200 shares of common stock for $20 per share. What is the entry?
General Journal Date Accounts and Explanations PR Debit Credit

Jul 23 Cash (6,200 x $10) Common Stock To record issuance of stock

124,000 124,000

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Preferred Stock
nAccounting for preferred stock

follows the pattern illustrated for common stock.

17

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Learning Objective 3
Describe how treasury stock transactions affect a company.

18

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Treasury Stock Transactions

nShares that a company has

issued and later reacquired. nReasons nStock purchase plan distribution nIncrease net assets nAvoidance of a takeover
19

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

IHOP Corp. Before Purchase of Treasury Stock

Stockholders Equity at December 31, 2005 (if no treasury stock purchased) Common Stock $ 203 Paid-in capital in excess of par 69,655 Retained earnings 193,632 Total equity $263,490

20

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

IHOP Corp. Purchase of Treasury Stock

During 2005, IHOP paid $5,170 to purchase 288 shares of its common stock as treasury stock.
General Journal Date Accounts and Explanations PR Debit Credit

Nov 1

Treasury Stock Cash Purchased treasury stock

5,170 5,170

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

IHOP Corp. After Purchase of Treasury Stock

Stockholders Equity at December 31, 2005 (with treasury stock purchased) Common Stock $ 203 Paid-in capital in excess of par 69,655 Retained earnings 193,632 Less: Treasury stock (288 shares at cost) (5,170) Total equity $258,320
2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Sale of Treasury Stock

Assume that on July 22, 2006, the shares of treasury stock are sold for $5,300.
General Journal Date Accounts and Explanations PR Debit Credit

Jul 22 Cash Treasury Stock Paid-in Capital from Treasury Stock Transactions Sold treasury stock

5,300 5,170 130

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

IHOP Corp. After Sale of Treasury Stock

Stockholders Equity at December 31, 2006 Common Stock Paid-in capital in excess of par Retained earnings Total equity Equity before purchase of treasury stocks Increase in stockholders equity
2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

203 69,785 193,632 $263,620 263,490 $ 130

Retirement of Stock
nDecreases the outstanding

stock of the corporation nRetired shares cannot be reissued nThere is no gain or loss on retirement
25

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Retained Earnings Account

Balance = Net income less -Net losses -Dividends declared

26

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Dividends and Splits

nDividend - corporations return

to its stockholders of some of the benefits of earnings nStock split - increase in the number of authorized, issued, and outstanding shares
27

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Dividend Dates
nDeclaration date nDate of record nPayment date

28

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Learning Objective 4
Account for dividends and measure their impact on a company.

29

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Preferred Stock Dividends

Pinecraft Industries, Inc., has both common stock and 100,000 shares of preferred stock outstanding. Preferred dividends are paid at the annual rate of $1.50 per share. In 20x9, the company declares an annual dividend of $1,000,000. Preferred dividend (100,000 $1.50 per share) Common dividend (remainder: $1,000,000 $150,000) Total dividend
2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

$150,000 850,000 $1,000,000

Preferred Stock Dividends

The preferred stock of Pinecraft is cumulative. Suppose the company passed the 20x6 preferred dividend of $150,000. In 20x7, the company declares a $500,000 dividend.
General Journal Date Accounts and Explanations PR Debit Credit

Retained Earnings Dividends Payable-Preferred Dividends Payable-Common Declared a cash dividend *$150,000 x 2 years
2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

500,000 300,000* 200,000

Stock Dividends
nSmall stock dividends: 25% or less nLarge stock dividends: above 25%

32

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Stock Dividend
IHOP declared a 10% stock dividend in 2006. Assume IHOP had 20,000,000 shares of common stock outstanding. The stock is trading for $15 per share. How would this stock dividend be recorded?
33

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Stock Dividend
Date General Journal Accounts and Explanations In thousands PR Debit Credit

Retained Earnings (20,000,000 X 10% X $15) Common Stock

(20,000,000 X 10% X $0.01)

30,000 20 29,980

Paid-in Capital in Excess of Par Common Distributed a 10% stock dividend

For a large stock dividend, debit Retained Earnings and credit Common Stock for the par value of the shares.
2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Stock Splits
nIncreases number of

authorized, issued, and outstanding shares of stock nProportionate reduction in stocks par value nDecreases market price
35

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Stock Splits
nThe market price of a share of

Quaker Oats has been approximately $25. Assume that the company wants to decrease it to $12.50. This 2-for-1 split means that the company would have twice as many shares outstanding after the split as is had before the split.

36

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Learning Objective 5
Use different stock values in decision making.

37

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Stock Values
nMarket value nRedemption value nLiquidation value nBook value

38

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Book Value Per Share

nPreferred stock = (Redemption value + Dividends in arrears) Number of shares of preferred outstanding nCommon stock =
(Total stockholders equity Preferred equity) Number of shares of common stock outstanding
39

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Book Value
Stockholders Equity Preferred stock, 6%, $100 par, 5,000 shares authorized, 400 shares issued, redemption value $130 per share Additional paid-in capital in excess of par preferred Common stock, $10 par, 20,000 shares authorized, 5,500 shares issued Additional paid-in capital in excess of par common Retained earnings Treasury stock common, 500 shares at cost Total stockholders equity
2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

$ 40,000 4,000 55,000 72,000 85,000 ( 15,000) $241,000

Book Value
Suppose that four years (including the current year) cumulative preferred dividends are in arrears and that preferred stock has a redemption value of $130 per share.
41

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Book Value
Preferred equity: Redemption value (400 shares 130) $ 52,000 Cumulative dividends ($40,000 $0.06 4 yrs) 9,600 Preferred equity $ 61,600 Common equity: Total stockholders equity Less preferred equity Common equity Book value per share: $179,400 5,000 shares* *5,500 shares issued minus 500 treasury shares
2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

$241,000 61,600 $179,400 $ 35.88

Learning Objective 6
Evaluate a companys return on assets and return on stockholders equity.

43

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Rate of Return on Total Assets

(Net income + Interest expense) Average total assets Measure of a companys ability to generate profits from the use of its assets.

44

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Return on Equity
Rate of return on common stockholders equity = (Net income Preferred dividends) Average common stockholders equity Measure of income earned from common stockholders investment in the company.
45

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Learning Objective 7
Report stockholders equity transactions on the statement of cash flows.

46

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Reporting Stockholders Equity Transactions

During 2003, IHOP issued stock, repurchased stock, but paid no dividends. Cash flows from financing activities:
Proceeds from issuance of common stock $172,000 Purchase of treasury stock (5,170,000) Net cash used by financing activities $(4,998,000)

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

End

48

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

Source:
nfaculty.tamucc.edu/shall/2301/p

owerpoint/fa6ch09.ppt

49

2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren