Private and Confidential

Equity Analyst Training Program

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Private and Confidential Not for Circulation
Prepared by: Dheeraj Vaidya
dheerajvaidya@corporatebridge.net
dheerajvaidya@gmail.com
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Discussion topics
Capital Stock
Corporate form of Organization
Corporation - Owners Equity
Common Stock
Preferred Stock
Cumulative Preferred Stock
Convertible Preferred Stock
Dividends
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Dividend Policy
Cash Dividends
Property Dividends
Stock Dividends
Stock Dividends Small
Stock Dividends Large
Stock Split
Treasury Stock
Other Comprehensive Income
Statement of changes in shareholders equity
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Capital Stock
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Private and Confidential Not for Circulation Private and Confidential Not for Circulation
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Corporate form of Organization
Business forms
Proprietorship Partnership
Corporation
Ownership Rules: One owner
Personal Liability: Unlimited
personal liability for the
Ownership Rules: Unlimited
number of shareholders allowed;
no limit on stock classes
Personal Liability: Generally
Ownership Rules: Unlimited
number of general partners
allowed
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personal liability for the
obligations of the business
Tax Treatment: Entity not
taxed, as the profits and losses
are passed through to the sole
proprietor
Mgmt of the Business: Sole
proprietor manages the business
Capital Contributions: Sole
proprietor contributes whatever
capital needed
Personal Liability: Generally
no personal liability of the
shareholders for the obligations
of the corporation
Tax Treatment: Corporation
taxed on its earnings at the
corporate level and the
shareholders have a further tax
on any dividends distributed
(double taxation)
Mgmt of the Business: Board
of Directors has overall
management responsibility and
officers have day-to-day
responsibility
Capital Contributions:
Shareholders typically purchase
stock in the corporation, either
common or preferred
Personal Liability: Unlimited
personal liability of the general
partners for the obligations of the
business
Tax Treatment: Entity not
taxed as the profits and losses
are passed through to the
general partners
Mgmt of the Business:
General partners have equal
management rights, unless they
agree otherwise
Capital Contributions:
General partners typically
contribute money or services to
the partnership, and receive an
interest in profits and losses
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Corporation - Owners Equity
Stockholders equity is the residual interest of the stockholders in the assets of the
corporation
Two primary sources of Equity Contributed Capital and Retained Earnings
Total Owners
Equity
Paid-in Capital
Retained
Earnings
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Private and Confidential Not for Circulation
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Retained Earnings account is linked to the Income Statement
Preferred Stock
Par or Stated
Value
Additional Paid-
In Capital
Common Stock
Par or Stated
Value
Additional Paid-
In Capital
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Capital Stock
Authorized Capital Stock
When a corporation is formed, the individuals who file the corporate charter with the state must first
determine the maximum number of shares the corporation will be authorized to issue
Authorized capital stock is the number of shares authorized for issue by the corporate charter
Authorized stock must allow for future flexibility so usually the authorized stock is more than the number
of shares the corporation plans to issue in the foreseeable future
Issued Shares
The number of shares that have been sold
Outstanding shares
The number of shares still in circulation
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The number of shares still in circulation
Outstanding Shares Issued Stock Treasury Stock
= -
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Common Stock
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Private and Confidential Not for Circulation Private and Confidential Not for Circulation
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Common Stock
McDonalds Shareholders Equity in 2006 and 2007
McDonald's Part - Balance Sheet ($ in mn, expect per share data) 2007 2006
Shareholders' Equity
Preferred stock, no par value; authorized 165.0 million shares; issued none $0 $0
Common stock, $.01 par value; authorized 3.5 billion shares; issued 1,660.6 million shares $17 $17
Additional paid-in capital $4,227 $3,445
Retained earnings $26,462 $25,846
Accumulated other comprehensive income (loss) $1,337 ($297)
Common stock in treasury, at cost; 495.3 and 456.9 million shares ($16,762) ($13,552)
Total shareholders equity $15,280 $15,458
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Total shareholders equity $15,280 $15,458
Authorized
Preferred
Stock, 165
Authorized
Common
Stock, 3,500
Shares
Issued, 1,661
Treasury
Shares, 495
Shares
Unissued, 1,509
McDonalds authorized shareholders
stock in 2007
McDonalds stock distribution
in 2007
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Common Stock
Each share of common stock conveys certain rights to the owner:
Attend stockholders meetings
Elect directors and vote on other matters
Receive dividends as declared by the board of directors
Preemptive right: The preemptive right is a shareholders right to purchase a proportionate amount of
any new stock issued at a later date
Shareholders Accounts need to be maintained for
Par Value (Par value has no economic significance)
Additional Paid-in Capital
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When par value stocks are issued:
When no-par value stocks are issued:
What is the par value for McDonalds ?
Why par value is so low?
Low par values help companies avoid a contingent liability.
Avoids confusion over recording par value versus fair market value.
Cash Proceeds
Number of Shares X
Par Value of Stock
Paid in capital in excess
of Par Value
= +
Cash Proceeds
Common Stock
Proceeds
=
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Common Stock
Cash proceeds $500,000
Common stock $10,000
Additional paid-in capital $490,000
Cash proceeds = $50 x 10,000 =
$500,000
Common Stock = $1 x 10,000 =
$10,000
Additional paid-in capital
Example: Common Stock
90 degrees Corp issued 10,000 shares of $1 par value stock for $50/share. What is common stock
and additional paid-in-capital?
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Private and Confidential Not for Circulation
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Costs of Issuing Stock includes direct costs incurred to sell stock, such as
Underwriting costs
Accounting and legal fees,
Printing costs
Taxes
Cost of issue should be reported as a reduction of the amounts paid in (additional paid-in
capital)
Additional paid-in capital
($50 - $1) x 10,000 = $490,000
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Preferred Stock
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Private and Confidential Not for Circulation Private and Confidential Not for Circulation
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Preferred Stock
Preferred stock has certain preferences or features not possessed by common stock
These features are:
Preference as to dividends
Absence of voting rights
Preference as to assets in the event of liquidation
May be convertibility into common stock at the option of the stockholders (Convertible Preferred Stock)
May be callable at the option of the issuer (Callable Preferred Stock)
These may also come with attached warrants (Preferred stock with stock warrants)
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Private and Confidential Not for Circulation
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Cumulative
All dividends must be paid before any
dividends can be paid to common shareholders
Cumulative
All dividends must be paid before any
dividends can be paid to common shareholders
Non-cumulative
If dividends are not paid, the company is not
required to make-up the missed dividends
Non-cumulative
If dividends are not paid, the company is not
required to make-up the missed dividends
Preferred Stock
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Cumulative Preferred Stock
Example: Preferred Stock
Following the previous example, 90 degree Corp also issued 1,000 shares of no par value, $5 cumulative
preferred stock for $80/share.
Net Income (2007) = $150,000
Dividends (2007) = $0
Calculate the total shareholder's equity?
Cash proceeds $80,000
Preferred stock capital $80,000
Preferred stock capital
= $80 x 1,000 = $80,000
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Private and Confidential Not for Circulation
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Dividends of $5 cumulative preferred stock?
In arrears on cumulative preferred stock = $5,000 (1,000 share x $5/share)
Preferred stock capital $80,000
90 degree Corp
Balance Sheet, 31st Dec 2007
Preferred shares (1,000 no par value ) $80,000
Common Stock (10,000 shares @ $1 par value $10,000
Additional paid-in capital (common stock) $490,000
Retained Earnings $150,000
Total Shareholders' Equity $730,000
Flows from the income statement
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Convertible Preferred Stock
Cash proceeds $75,000
Preferred stock, $100 par $50,000
Preferred stock Additional paid- in Capital $25,000
Upon conversion of the preferred
convertible stocks
Example: Convertible Preferred Stock
Following the previous example, 90 degree Corp has also issued 500 shares of $100 par convertible
preferred stock for $150/share.
Each share of preferred stock may be converted into three shares of $1 par common stock
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Each preferred is converted into three
common stock
$1 x 500 x 3 = $1,500
Cash proceeds $75,000
Common stock, $1 par $1,500
Additional paid-in capital from preferred stock $73,500
90 degree Corp
Balance Sheet, 31st Dec 2007
Preferred shares (1,000 no par value ) $80,000
Convertible preferred shares ($100 par value ) $50,000
Preferred stock Additional paid- in Capital $25,000
Common Stock (10,000 shares @ $1 par value $10,000
Additional paid-in capital (common stock) $490,000
Retained Earnings $150,000
Total Shareholders' Equity $805,000
Before conversion of
preferred stock
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Dividends
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Private and Confidential Not for Circulation Private and Confidential Not for Circulation
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Dividend Policy
Dividend distributions generally are based on accumulated profits (retained earnings)
Few companies pay dividends in amounts equal to their legally available retained earnings.
Maintain agreements with creditors
Meet state incorporation requirements
To finance growth or expansion
To smooth out dividend payments
To build up a cushion against possible losses
Important types of Dividends
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Private and Confidential Not for Circulation
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Dividends Dividends
Cash
dividends
Cash
dividends
Property
dividends
Property
dividends
Stock
dividends
Stock
dividends
Dividends require information concerning
three dates
Date of declaration
Date of record
Date of payment
Dividends require information concerning
three dates
Date of declaration
Date of record
Date of payment
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Cash Dividends
Board of directors vote on the declaration of cash dividends
The company must have sufficient cash and retained earnings to pay the dividend
Companies do not declare or pay cash dividends on treasury stock
Company is not legally required to pay dividends, but once declared a legal liability is created
Date of Declaration (March 15
th
, 2008)
Example: Cash Dividend
What would be the accounting entries made by a corporation that declared a $100,000 cash dividend on
March 15, payable on April 20 to shareholders of record on April 2?
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Date of Declaration (March 15
th
, 2008)
Date of Record (April 2
nd
, 2008) NO ENTRY
Date of Payment (April 20
th
, 2008)
Assets Liability Shareholders Equity = +
Retained Earnings
decreases by $100,000
Dividends payable
increases by $100,000
Assets Liability Shareholders Equity = +
Cash decreases by
$100,000
Dividends payable
decreases by $100,000
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Property Dividends
Sometimes a corporation will declare a property dividend that is payable in assets other than
cash
The corporation typically uses marketable securities of other companies that it owns for the
property dividend
Gain on Investments = ($135,000 - $100,000) = $35,000
Date of Declaration (January 5
th
, 2008)
Example: Property Dividend
A dividend is declared January 5, 2008 and paid January 25,2008 in bonds held as an investment; the bonds
have a book value of $100,000 and a fair market value of $135,000. The record date is January 20th, 2008
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Date of Declaration (January 5
th
, 2008)
Date of Record (January 20
th
, 2008) NO ENTRY
Date of Payment (January 25
th
, 2008)
Assets Liability Shareholders Equity = +
Retained Earnings
decreases by $135,000
Dividends payable
increases by $135,000
Assets Liability Shareholders Equity = +
Investment in bonds
decreases by $135,000
Dividends payable
decreases by $135,000
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Stock Dividends
Issuance of own stock to stockholders on a pro rata basis, without receiving any
consideration
Shareholder's do not receive corporate assets and their percentage ownership does not
change
Advantages of Stock Dividends
The stockholders may see the stock dividend as evidence of corporate growth
The stockholders may see the stock dividend as evidence of sound financial policy
Other investors may see the stock dividend in a similar light, and increased trading in the stock may
cause the market price not to decrease proportionally
The stockholders may see the market price decreasing to a lower trading range, making the stock more
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The stockholders may see the market price decreasing to a lower trading range, making the stock more
attractive to additional investors so that the market price may eventually rise
Accounting for Stock Dividends
Stock
Dividends
Small (20%
to 25%)
Fair Value
Retained
Earnings
Capital
Stock
Additional
paid-in
capital
Large
Par Value
Retained
Earnings
Capital
Stock
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Stock Dividends - Small
90 degree Corp
Balance Sheet (Prior to dividends declaration)
Common Stock (10,000 shares @ $1 par value) $10,000
Additional paid-in capital (common stock) $490,000
Retained Earnings $150,000
Total Shareholders' Equity $650,000
Prior to dividend
declaration
Prior to dividend
declaration
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Example: Stock Dividend (Small)
90 Degree Corp has declared and issued a 20% stock dividend. On the date of declaration, the stock sells
at $50/share. Show the accounting entries
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Total Shareholders' Equity $650,000
90 degree Corp
Balance Sheet (Post to dividends declaration)
Common Stock (12,000 shares @ $1 par value) $12,000
Additional paid-in capital (common stock) $588,000
Retained Earnings $50,000
Total Shareholders' Equity $650,000
Post dividend declaration Post dividend declaration
Additional Common Stock:
$1 x 10,000 X 20% = $2,000
Additional Paid in Capital due to stock
dividends
$($50-$1) x 10,000 X 20% = $98,000
Retained Earnings reduces
$150,000 - $100,000
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Stock Dividends - Large
90 degree Corp
Balance Sheet (Prior to dividends declaration)
Common Stock (10,000 shares @ $1 par value) $10,000
Additional paid-in capital (common stock) $490,000
Retained Earnings $150,000
Total Shareholders' Equity $650,000
Prior to dividend
declaration
Prior to dividend
declaration
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Example: Stock Dividend (Large)
90 Degree Corp has declared and issued a 40% stock dividend. On the date of declaration, the stock sells
at $50/share. Show the accounting entries
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Total Shareholders' Equity $650,000
Post dividend declaration Post dividend declaration
Additional Common Stock:
$1 x 10,000 X 40% = $4,000
NO CHANGE
Retained Earnings reduces
$150,000 - $4,000 = $146,000
90 degree Corp
Balance Sheet (Post to dividends declaration)
Common Stock (14,000 shares @ $1 par value) $14,000
Additional paid-in capital (common stock) $490,000
Retained Earnings $146,000
Total Shareholders' Equity $650,000
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Stock Split
Typically done to reduce the market value of shares
No entry recorded for a stock split
Decrease par value and increase the number of shares
Example: Stock Split
90 Degree Corp has done a 2:1 stock split.Show the accounting entries
90 degree Corp
Balance Sheet (Prior to Stock Split)
Common Stock (10,000 shares @ $1 par value) $10,000
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Common Stock (10,000 shares @ $1 par value) $10,000
Additional paid-in capital (common stock) $490,000
Retained Earnings $150,000
Total Shareholders' Equity $650,000
90 degree Corp
Balance Sheet (Post Stock Split)
Common Stock (20,000 shares @ $0.5 par value) $10,000
Additional paid-in capital (common stock) $490,000
Retained Earnings $150,000
Total Shareholders' Equity $650,000
Total number of shares
increases to 20,000 and par
value decreases to
$0.5/share
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Treasury Stock
Treasury stock is a corporations own capital stock that
Has been fully paid for by stockholders
Has been legally issued
Reacquired by the corporation
Held by the corporation for future reissuance
Rationale for Stock Repurchase
To provide tax-efficient distributions of excess cash to shareholders
To increase earnings per share and return on equity
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To increase earnings per share and return on equity
To provide stock for employee stock compensation contracts or to meet potential merger needs
To thwart takeover attempts or to reduce the number of stockholders
To make a market in the stock
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Other Comprehensive Income
Comprehensive income includes both net income and other comprehensive income
Accumulated other comprehensive income might include four items
Unrealized increases (gains) or decreases (losses) in the market value of investments in available-for-sale
securities
Transaction adjustments from converting the financial statements of a companys foreign operations into
U. S. dollars
Certain gains and losses on derivative financial instruments
Certain pension liability adjustments
A corporation may report its comprehensive income
On the face of its income statement
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On the face of its income statement
In a separate statement of comprehensive income
In its statement of changes in stockholders equity
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Statement of changes in shareholders equity
Although not a required separate financial statement, some corporations include a statement
of retained earnings in their financial statements
What information does this statement provides?
Look at the McDonalds Statement of Shareholders Equity
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