CHAPTER 18 CHAPTER 18

Shareholders Equity Shareholders Equity

Overview
We turn our attention in this chapter from liabilities, which represent the creditors interests in the
assets of a corporation, to the shareholders residual interest in those assets. The discussions
distinguish between the two basic sources of shareholders equity (1) invested capital and ()
earned capital. These two sources are the sub!ects of "arts # and $ of this chapter paid%in capital
and retained earnings. We e&plore the e&pansion of corporate capital through the issuance of shares
as well as the contraction caused by the retirement of shares or the purchase of treasury shares.
Within the conte&t of our discussions of retained earnings, we e&amine cash di'idends, property
di'idends, stoc( di'idends, and stoc( splits.
LEARNIN O!"ECTI#ES
)fter studying this chapter, you should be able to*
)fter studying this chapter, you should be able to*
LO18-1 +escribe the components of shareholders equity and e&plain how they are reported in
a statement of shareholders, equity.
LO18-2 +escribe comprehensi'e income and its components.
LO18-3 -nderstand the corporate form of organi.ation and the nature of stoc(.
LO18-4 /ecord the issuance of shares when sold for cash and noncash consideration.
LO18-5 +istinguish between accounting for retired shares and treasury shares.
LO18-6 +escribe retained earnings and distinguish it from paid%in capital.
LO18-7 0&plain the basis of corporate di'idends, including the similarities and differences
between cash and property di'idends.
LO18-8 0&plain stoc( di'idends and stoc( splits and we account for them.
LO18-9 +iscuss the primary differences between -.1. 2))" and 34/1 with respect to
accounting for shareholders equity.
Le$ture Outli%e Le$ture Outli%e
Part A& The Nature o' Shareholders Equity
I( Sour$es o' Shareholders Equity
). ) company can raise money e&ternally to fund operations in either of two ways*
1. +ebt financing.
a. Ta(es the form of notes, bonds, leases, and other liabilities.
b. $reates creditors interest in the assets of the business.
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. 0quity financing.
a. $reates ownership interests in the assets of the business.
b. 5wners of a corporation are its shareholders.
c. Shareholders equity is a residual amount, the amount that remains
after creditor claims have been subtracted from assets. (T18-1)
#. 1hareholders equity is created mainly by*
1. )mounts in'ested by shareholders paid%in capital.
. )mounts earned by the firm on behalf of its shareholders retained earnings.
II( Shareholders Equity i% )i%a%$ial State*e%ts
). The balance sheet reports balances of shareholders equity accounts. (T16%)
#. $omprehensi'e income, a more e&pansi'e 'iew of the change in shareholders equity than
traditional net income, is the total nonowner change in equity for a reporting period.
Transactions between the corporation and its shareholders primarily include di'idends and
the sale or purchase of shares of the companys stoc(. 7onowner changes other than those
that are part of traditional net income are the ones reported as 8other comprehensi'e
income.9 5ther comprehensi'e income is reported in two places.
1. $omponents of comprehensi'e income created during the reporting period % can be
reported either (a) as an additional section of the income statement, (b) as part of the
statement of shareholders equity, or (c) as a separate statement, often included in the
financial statements in a disclosure note. 0ach component is reported net of its related
income ta& e&pense or income ta& benefit. (T16%:)
. The comprehensi'e income accumulated o'er the current and prior periods is
reported as a separate component of shareholders equity.
$. The statement of shareholders equity discloses transactions that cause changes in
shareholders equity account balances. (T16%;)
Part !& Paid+I% Ca,ital
I( )u%da*e%tal Share Ri-hts
). -sually ownership rights held by common shareholders include the right to*
1. <ote.
. 1hare in profits when di'idends are declared.
:. 1hare in the distribution of assets if the company is liquidated.
#. -sually the special rights of preferred shareholders include a preference*
1. To a specified amount of di'idends so that if the board of directors declares
di'idends, preferred shareholders recei'e the designated di'idend before any
di'idends are paid to common shareholders.
. 5'er common shareholders as to the distribution of assets in the e'ent the
corporation is dissol'ed.
$. +i'idends on cumulati'e preferred shares that are not declared in any gi'en year must be
paid the ne&t time di'idends are paid before any can be paid to common shareholders.
+. When preferred shares are not 8participating,9 shareholders are entitled to no more than
the designated di'idend preference.
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II( The Co%$e,t o' Par #alue
). "ar 'alue has little significance other than historical.
#. "ar 'alue originally indicated the actual 'alue of shares, but this is no longer the case.
$. $ompanies usually assign shares a nominal par 'alue to elude elaborate statutory rules
pertaining to par 'alue shares.
+. When shares are issued, we record the par amount in common stoc( and the remainder of
the proceeds in additional paid%in capital.
III( A$$ou%ti%- 'or the Issua%$e o' Shares
). When shares are sold for cash, shareholders in'estment is allocated between stated capital
and additional paid%in capital. (T16%=)
#. )t times, shares are sold for noncash consideration li(e a ser'ice or a noncash asset.
(T16%>)
1. The transaction should be recorded at the fair 'alue of either the shares or the
noncash consideration, whiche'er seems more clearly e'ident.
. This is consistent with the general rule for accounting for any noncash transaction.
$. ?ore than one security might be sold for a single price.
1. The cash recei'ed usually is the sum of the separate mar(et 'alues of the two
securities. 0ach is then recorded at its mar(et 'alue.
. 3f only one securitys 'alue is (nown, the second securitys mar(et 'alue is in'erred
from the total selling price. (T16%@)
:. 3f the total selling price is not equal to the sum of the two mar(et prices, the total
selling price is allocated between the two securities in proportion to their relati'e
mar(et 'alues.
0. 1hare issue costs are the costs of the legal, promotional, and accounting ser'ices
necessary to effect the sale of shares.
1. The costs reduce the net cash proceeds from selling the shares and thus paid%in
capital e&cess of par.
. 1hare issue costs are not recorded separately.
4. -.1. 2))" and 34/1 are generally compatible with respect to accounting for
shareholders, equity. 1ome differences e&ist in presentation format and terminology and in
choices regarding reporting comprehensi'e income. (T16%6)
I#( Rea$quired Shares
). $ompanies sometimes reacquire shares pre'iously sold.
1. The most common moti'ation is to support the mar(et price of the shares.
. )ll share repurchases are functionally the same.
:. )ccounting treatment depends on whether the company states that it is formally
retiring the shares or purchasing treasury shares. (T16%A) (T16%1B) (T16%11)
#. When a corporation formally retires pre'iously issued shares, those shares assume the
same status as authori.ed but unissued shares !ust the same as if they ne'er had been
issued.
1. "ayments to retire shares are 'iewed as a distribution of corporate assets to
shareholders.
. We decrease precisely the same accounts that pre'iously were increased when the
shares were sold namely, common (or preferred) stoc( and paid%in capital e&cess
of par.
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:. The difference between the cash paid to buy the shares and the amount the shares
originally sold for are treated differently depending on whether that difference is
positi'e (credit) or negati'e (debit)*
a. 3f a credit difference is created, we credit paid in capital share repurchase.
b. 3f a de(it difference is created, we debit retained earnings unless a credit balance
already e&ists in paid in capital share repurchase, in which case we debit that
account.
$. $orporations often 'iew a share buybac( as a purchase of treasury stoc(.
1. The cost of acquiring the shares is 8temporarily9 debited to the treasury stoc(
account.
. We delay recording the effects on specific shareholders equity accounts until later
when the shares are reissued.
:. 0ssentially, we 'iew the purchase of treasury stoc( as a temporary reduction of
shareholders, equity, re'ersed later when the treasury stoc( is resold.
;. When the treasury shares are resold, we treat the difference between the cash
recei'ed and the amount the shares originally cost differently depending on whether
that difference is positi'e (credit) or negati'e (debit)*
a. 3f a credit difference is created, we credit paid%in capital share repurchase.
b. 3f a de(it difference is created, we debit retained earnings unless a credit balance
already e&ists in paid%in capital share repurchase, in which case we debit that
account.
Part C& Retai%ed Ear%i%-s
I( The Nature o' Retai%ed Ear%i%-s
). 3n "art #, we studied invested capital. 3n "art $, we consider earned capital, usually
referred to as retained earnings. (T16%1)
#. 3n general, retained earnings represents a corporation,s accumulated, undistributed or
rein'ested net income (or net loss).
$. +istributions of earned assets are di'idends.
+. We refer to a de(it balance in retained earnings as a deficit.
II( .ivide%ds
). ?ost corporate di'idends are paid in cash. )t the declaration date, retained earnings is
reduced and a liability is recorded. /egistered owners of shares on the date of record are
entitled to recei'e the di'idend. (T16%1:)
#. 5ccasionally, a noncash asset is distributed. 3n that case it is referred to as a property
di'idend. The fair mar(et 'alue of the assets to be distributed is the amount recorded for a
property di'idend. #efore recording the property di'idend, the asset may need to be
written up or down to fair mar(et 'alue. This would create a gain or loss. (T16%1;)
III( Sto$/ .istri0utio%s
). 3n a stoc( di'idend, additional shares of stoc( are distributed to e&isting shareholders.
1. ) stoc( di'idend affects neither the assets nor the liabilities of the firm.
. #ecause each shareholder recei'es the same percenta%e increase in shares, each
shareholders percentage ownership of the firm remains the same.
:. 4or a CsmallC stoc( di'idend (=D or less), the fair 'alue of the additional shares
distributed is transferred from retained earnings to paid%in capital. (T16%1=)
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#. ) stoc( distribution of =D or higher is a stoc( split. (T16%1>)
1. 3f referred to merely as a stoc( split, no !ournal entry is recorded.
. 3f referred to as a Cstoc( split effected in the form of a stoc( di'idend,C the par 'alue
of the additional shares is reclassified within shareholders equity.
.e$isio%+1a/ers Pers,e$tive
). "rofitability is 'ital to a company,s long run sur'i'al.
#. The return on shareholders, equity is a popular summary measure of profitability.
1. The return on shareholders, equity is calculated by di'iding net income by a'erage
shareholders, equity
. The return on shareholders, equity measures the ability of company management to
generate net income from the resources that owners pro'ide.
$. )nalysts often supplement the return on shareholders equity ratio with the earnings%price
ratio.
1. This ratio relates earnings to the mar(et 'alue of equity rather than the boo( 'alue of
equity.
. 3t is calculated as the earnings per share di'ided by the mar(et price per share.
:. ) common 'ariation is the in'erse the price%earnings ratio.
+. 1hareholders equity transactions can affect the return to shareholders.
1. When a company buys bac( some of its shares, the return on shareholders equity
goes up.
. 5n the other hand, the buybac( of shares uses assets, which decreases the resources
a'ailable to earn net income in the future.
0. )nalysts should e'aluate di'idend decisions with consideration for pre'ailing
circumstances. ?anagement must decide whether shareholders are better off recei'ing
cash di'idends or ha'ing funds rein'ested in the firm.
A,,e%di2 18& 3uasi+Reor-a%i4atio%s
). ) quasi%reorgani.ation aids a company that e&periences financial difficulties, and yet has
fa'orable future prospects.
1. 3nflated asset 'alues are written down.
. The accumulated deficit (debit balance in retained earnings) is eliminated.
#. )ssets (and liabilities if necessary) are written up or down to reflect fair 'alues.
1. $orresponding credits or debits are made to retained earnings.
. The deficit usually is temporarily increased by this step.
$. The deficit in retained earnings (debit balance) is eliminated.
1. /etained earnings is creditedE additional paid%in capital is debited.
. 3f additional paid%in capital is not sufficient to absorb the entire deficit, common
stoc( is debited also.
+. /etained earnings is 8dated9 to indicate the date the deficit was eliminated and when the
new accumulation of earnings began.
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PowerPoi%t Slides PowerPoi%t Slides
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Tea$hi%- Tra%s,are%$y 1asters Tea$hi%- Tra%s,are%$y 1asters
The following can be reproduced on transparency film as they appear here, or
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SHAREHOL.ERS E35IT6
1hareholders equity accounts represent the ownership
interests of shareholders. 1hareholders equity is a residal
amount whats left o'er after creditor claims ha'e been
subtracted from assets (in other words, net assets).
Assets 7 Lia0ilities 8 Shareholders equity
Net Assets
5wnership interests of shareholders arise primarily from
two sources (1) amounts invested by shareholders in the
corporation and () amounts earned by the corporation on
behalf of its shareholders. These two sources are reported
as (1) ,aid+i% $a,ital and () retai%ed ear%i%-s.
) third source is )ccumulated 5ther $omprehensi'e
3ncome
T16%1
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T16%
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0&position $orporation
!ala%$e Sheet 9: i% *illio%s;
+ecember :1, B1:
Assets
FG:,BBBH
Lia0ilities
FG1,BBBH
Shareholders equity
PAI.+IN CAPITAL&
Capital stock (par):
"referred stoc(, 1BD, G1B par,
cumulati'e, nonparticipating G1BB
$ommon stoc(, G1 par ==
$ommon stoc( di'idends distributable =
Additional Paid-in Capital:
"aid%in capital e&cess of par, common >B
"aid%in capital e&cess of par, preferred =B
"aid%in capital share repurchase 6
"aid%in capital con'ersion of bonds @
"aid%in capital stoc( options A
"aid%in capital stoc( award plan =
"aid%in capital lapse of stoc( options 1
Total paid-in capital G =BB
RETAINE. EARNINS 1,>@B
ACC515LATE. CO1PONENTS O) CO1PREHENSI#E INCO1E&
-nreali.ed gains (losses) on in'estment securities (6=)
-nreali.ed net loss on pensions (@=)
+eferred gains (losses) on deri'ati'es (;)
4oreign currency translation ad!ustments %B % (1>;)
TREAS5R6 STOC< (at cost) (> )
Total shareholders equity G,BBB
CO1PREHENSI#E INCO1E
0ncompasses all changes in equity other than from transactions with
owners.
7onowner changes other than those that are part of traditional net
income are the ones reported as 8other comprehensi'e income.9
$omprehensi'e income accmlated o'er the current and prior
periods is reported in the shareholders equity section of the balance
sheet.
$omponents of comprehensi'e income created drin% the reportin%
period can be reported either (a) as an additional section of the
income statement, (b) as part of the statement of shareholders equity,
or (c) as a separate statement in a disclosure note*
(G in millions)
7et income G&&&
5ther comprehensi'e income*
7et unreali.ed holding gains (losses) on in'estments (net of ta&)I G &
2ains (losses) from and amendments to postretirement plans (net of ta&)J (&)
+eferred gains (losses) from deri'ati'es (net of ta&)
K
(&)
2ains (losses) from foreign currency translation (net of ta&)L & &&
$omprehensi'e income G&&&
I $hanges in the fair 'alue of some securities.
J 2ains and losses due to re'ising assumptions or mar(et returns differing from e&pectations and
prior ser'ice cost from amending the plan (described in $hapter 1@).
K
When a deri'ati'e designated as a cash flow hedge is ad!usted to fair 'alue, the gain or loss is
deferred as a component of comprehensi'e income and included in earnings later, at the same
time as earnings are affected by the hedged transaction (described in the +eri'ati'es )ppendi&
to the te&t).
L 2ains or losses from changes in foreign currency e&change rates. The amount could be an
addition to or reduction in shareholders equity. (This item is discussed elsewhere in your
accounting curriculum.)
T16%:
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STATE1ENT O) SHAREHOL.ERS= E35IT6
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>al+1art A$$u*( Total
Ca,ital i% Other >al*art
Co**o% E2$ess o' Retai%ed Co*,r( Sh?Hdrs
(3n millions, e&cept per share amounts) Shares Sto$/ Par #alue Ear%i%-s I%$o*e Equity
Balances February 1, 2008 3,973 $397 $3,028 $57,022 $3,864 $64,311
Consolidated net income 13,381 13,381
Other comprehensive income (6,552) (6,552)
Cash dividends ($0.95 per share) (3,746) (3,746)
Purchase of Company stock (61) (6) (95) (3,315) (3,416)
Other 13 2 987 2 991





Balances January 31, 2009 3,925 393 3,920 63,344 (2,688) 64,969

Consolidated net income 14,370 14,370

Other comprehensive income 2,618
2,618
Cash dividends ($1.09 per share) (4,217) (4,217)
Purchase of Company stock (145) (15) (246) (7,136) (7,397)
Purchase of redeemable
noncontrolling interest (288) (288)
Other 6 417 (4 ) 413




Balances January 31, 2010 3,786 378 3,803 66,357 (70) 70,468

Consolidated net income 16,389 16,389

Other comprehensive income 716 716

Cash dividends ($1.21 per share) (4,437) (4,437)
Purchase of Company stock (280) (28) (487) (14,319) (14,834)
Other 10 2 261 (23 ) 240




Balances January 31, 2011 3,516 $352 $3,577 $63,967 $646 $68,542






T16%;
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SHARES SOL. )OR CASH
When shares are sold for cash, the capital stoc( account
(usually common or preferred) is credited for the amount
representing stated capital. When shares ha'e a designated
par 'alue, that amount denotes stated capital and is credited to
the stoc( account. "roceeds in e&cess of this amount are
credited to paid%in capital e&cess of par.
+ow 3ndustrial sells 1BB,BBB of its common shares, G1 par per
share, for G1B per share*
(G in BBBs)
$ash (1BB,BBB shares at G1B price per share)....................... 1,BBB
$ommon stoc( (1BB,BBB shares at G1 par )................... 1BB
"aid%in capital e&cess of par (remainder).............. ABB
The entire proceeds from the sale of nopar stoc( are deemed
stated capital and recorded in the stoc( account.
3f the shares are nopar, the entry is as follows*
$ash (1BB,BBB shares at G1B price per share)....................... 1,BBB
$ommon stoc( .................................................... 1,BBB
T16%=
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SHARES SOL. )OR NONCASH CONSI.ERATION
5ccasionally, a company might issue its shares for
consideration other than cash. 3t is not uncommon for a new
company, yet to establish a reliable cash flow, to pay for
promotional and legal services with shares rather than with
cash. 1imilarly, shares might be gi'en in payment for land, or
for equipment, or for some other noncash asset.
1hares should be issued at whiche'er e'idence of fair mar(et
'alue seems more clearly e'ident.
+u?ont $hemicals issues 1 million of its common shares, G1
par per share, in e&change for a custom%built factory for which
no cash price is a'ailable. Todays issue of the -all .treet
/ornal lists +u?onts stoc( at G1B per share*
(G in millions)
"roperty, plant, and equipment (1 million shares at G1B).... 1B
$ommon stoc( (1 million shares at G1 par )..................... 1
"aid%in capital e&cess of par (remainder)................. A
T16%>
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1ORE THAN ONE SEC5RIT6
SOL. )OR A SINLE PRICE
?ore than one security might be sold for a single price. The
cash recei'ed usually is the sum of the separate mar(et 'alues
of the two securities. 0ach is then recorded at its mar(et
'alue.
3f only one securitys 'alue is (nown, the second securitys
mar(et 'alue is in'erred from the total selling price.
)"M" issues ; million of its common shares, G1 par per share,
and ; million of its preferred shares, G1B par, for G1BB million.
Todays issue of the -all .treet /ornal lists )"M"s common at
G1B per share. There is no established mar(et for the preferred
shares*
(G in millions)
$ash........................................................................... 1BB
$ommon stoc( (; million shares & G1 par) ...................... ;
"aid%in capital e&cess of par, common................. :>
"referred stoc( (; million shares & G1B par)..................... ;B
"aid%in capital e&cess of par, preferred................ B
3f the total selling price is not equal to the sum of the two
mar(et prices, the total selling price is allocated between the
two securities in proportion to their relati'e mar(et 'alues.
T16%@
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INTERNATIONAL )INANCIAL REPORTIN STAN.AR.S
5se o' the ter* @reservesA a%d other ter*i%olo-y di''ere%$es( 1hareholders equity
is classified under 34/1 into two categories* 1hare capital and 8reser'es.9 The term
reser'es is considered misleading and thus is discouraged under -.1. 2))". Nere are
some other differences in equity terminology*
U.S. GAAP IFRS
Capital stock: Share capital:
Common stock Ordinary shares
Preferred stock Preference shares
Paid-in capitalexcess of par, common Share premium, ordinary
shares
Paid-in capitalexcess of par, preferred Share premium, preference
shares
Accumulated other comprehensive income: Reserves:
et !ains "losses# on investmentsAOC$ $nvestment revaluation
reserve
et !ains "losses# currency translation AOC$ %ranslation
reserve
{N/A: adjusting P,P, & E to fair value not permitted} Revaluation
reserve
Retained earnin!s Retained earnin!s
Total shareholers! e"#$t% Total e"#$t%
Presented after &ia'ilities Often presented 'efore
&ia'ilities
T16%6
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CO1PARISON O) SHARE RETIRE1ENT AN.
TREAS5R6 STOC< ACCO5NTIN
7 SHARE !56!AC<S
)merican 1emiconductors balance sheet included the following*
Shareholders= Equity (G in millions)
$ommon stoc(, 1BB million shares at G1 par ............. G 1BB
"aid%in capital e&cess of par..................................... ABB
"aid%in capital share repurchase...............................
/etained earnings........................................................ ,BBB
Retire*e%t Treasury Sto$/
Rea$quired 1 *illio% o' its $o**o% shares
Case 1& Shares re,ur$hased at :B ,er share
$ommon stoc( (G1 par & 1 million sh). 1 Treasury stoc( (cost).............. @
"3$ e&cess of par (GA per sh)......... A
"3$ share repurchase (difference) :
$ash............................................ @ $ash................................... @

OR
Case C& Shares re,ur$hased at :1D ,er share
$ommon stoc( (G1 par & 1 million sh). 1 Treasury stoc( (cost)............... 1:
"3$ e&cess of par (GA per sh)......... A
"3$ share repurchase .................. L
/etained earnings (difference)........... 1
$ash............................................ 1: $ash................................... 1:
L#ecause there is a G million credit balance.
T16%A
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CO1PARISON O) SHARE RETIRE1ENT AN.
TREAS5R6 STOC< ACCO5NTIN
7 S5!SE35ENT SALE O) SHARES
)merican 1emiconductor sold 1 million shares after reacquiring shares at G1: per share
($ase in 3llustration 16%1B)
Retire*e%t Treasury Sto$/
Case A& Shares sold at :1E ,er share
$ash................................... 1; $ash............................................ 1;
$ommon stoc( (par)........ 1 Treasury stoc( (cost) .............. 1:
"3$ e&cess of par........ 1: "3$ share repurchase.......... 1
OR
Case !& Shares sold at :1F ,er share
$ash................................... 1B $ash............................................ 1B
$ommon stoc( (par)........ 1 /etained earnings (to balance)....... 1
"3$ e&cess of par ......... A "3$ share repurchase .............. L
Treasury stoc( (cost).............. 1:
L#ecause there is a G million credit balance.
T16%1B
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REPORTIN SHARE !56!AC<S IN THE
!ALANCE SHEET

When a share repurchase is 'iewed as treasury stoc(, the cost of

the treasury stoc( is simply reported as a reduction in total
shareholders equity.
Shares Treasury
Retired Sto$/
Shareholders Equity (G in millions)
Paid+i% $a,ital&
$ommon stoc(, 1BB million shares at G1 par G AA G 1BB
"aid%in capital e&cess of par 6A1 ABB
"aid%in capital share repurchase
Retai%ed ear%i%-s 1,AAA ,BBB
Oess* Treasury stoc(, 1 million shares (at cost) (1: )
Total shareholders equity G,A6A G,A6A
T16%11
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4ormally retiring shares restores the balances in both the $ommon
stoc( account and "aid%in capital e&cess of par to what those
balances would ha'e been if the shares ne'er had been issued at
all.
o )ny net increase in assets resulting from the sale and
subsequent repurchase is reflected as Paid-in capital
share repurchase.
o )ny net decrease in assets resulting from the sale and
subsequent repurchase is reflected as a reduction in
retained earnings.
RETAINE. EARNINS
3n general, retained earnings represents a corporation,s
accumulated, undistributed, or rein'ested net income (or net
loss). 3t also is called 8rein'ested capital9 or 8earned capital.9
+istributions of earned assets are di'idends.
) debit balance in retained earnings is referred to as a deficit.
) restriction of retained earnings communicates
managements intention to withhold assets represented by a
specified portion of the retained earnings balance (normally
indicated by a disclosure note).
T16%1
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Instrctors! "esorce Manal 1#-1,
CASH .I#I.EN.S
5n Pune 1, the board of directors of $raft 3ndustries declares a
cash di'idend of G per share on its 1BB million shares, payable
to shareholders of record Pune 1=, to be paid Puly 1*
(G in millions)
"u%e 1 7 de$laratio% date
/etained earnings............................................... BB
$ash di'idends payable
(1BB million shares at GQshare) ............................ BB
"u%e 1D 7 e2+divide%d date
no entry
"u%e 1G 7 date o' re$ord
no entry
"uly 1 7 ,ay*e%t date
$ash di'idends payable .................................... BB
$ash ............................................................. BB
T16%1:
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1#-20 Intermediate $ccontin%, &e
PROPERT6 .I#I.EN.S
#efore recording a property di'idend, the asset first must be
written up to fair mar(et 'alue.
5n 5ctober 1, the board of directors of $raft 3ndustries
declares a property di'idend of million shares of #eaman
$orporations preferred stoc( that $raft had purchased in
?arch as an in'estment (boo( 'alue* GA million).
The in'estment shares ha'e a fair mar(et 'alue of G= per
share and are payable to shareholders of record 5ctober 1=,
to be distributed 7o'ember 1*
O$to0er 1 7 de$laratio% date (G in millions)
3n'estment in #eaman $orporation
preferred stoc( .......................................... 1
2ain on appreciation of in'estment (G1B GA) 1
/etained earnings ( million shares at G= per share) 1B
"roperty di'idends payable ................... 1B
O$to0er 1G 7 date o' re$ord
no entry
Nove*0er 1 7 ,ay*e%t date
"roperty di'idends payable .......................... 1B
3n'estment in #eaman $orporation
preferred stoc( .................................... 1B
T16%1;
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Instrctors! "esorce Manal 1#-21
STOC< .I#I.EN.S
) stoc( di'idend is the distribution of additional shares o'
stoc0 to crrent shareholders of the corporation.
#ecause each shareholder recei'es the same percenta%e
increase in shares, shareholders, proportional interest in
(percentage ownership of) the firm remains unchanged.
4or a CsmallC stoc( di'idend (less than =D), the 'air mar0et
vale of the additional shares distributed is transferred from
retained earnings to paid%in capital.
$raft declares and distributes a 1BD common stoc( di'idend
(1B million shares) when the mar(et 'alue of the G1 par common
stoc( is :1C per share*
(G in millions)
/etained earnings (1B million shares at G1 per share)..... 1B
$ommon stoc( (1B million shares at G1 par per share) . . 1B
"aid%in capital e&cess of par (remainder)............ 11B
T16%1=
The McGraw-Hill Companies, Inc., 2013
1#-22 Intermediate $ccontin%, &e
STOC< SPLITS
) stoc( distribution of =D or higher is referred to as a stoc(
split.
) frequent reason for issuing a stoc( split is to reduce the
mar(et price per share (by half in a for 1 split, for e&ample).
The proper accounting treatment of stoc( split is to ma(e no
!ournal entry, unless the stoc( distribution is referred to as a
Cstoc( split effected in the form of a stoc( di'idend.C
$raft declares and distributes a for 1 stoc( split effected
in the form of a 1BBD stoc( di'idend (1BB million shares)
when the mar(et 'alue of the G1 par common stoc( is G1
per share*
(G in millions)
"aid%in capital e&cess of par.......................... 1BB
$ommon stoc( (1BB million shares at G1 par) ........ 1BB
1ome companies choose to debit retained earnings instead*
/etained earnings.............................................. 1BB
$ommon stoc( (1BB million shares at G1 par) ........ 1BB
T18+1H
The McGraw-Hill Companies, Inc., 2013
Instrctors! "esorce Manal 1#-23
Su--estio%s 'or Class A$tivities Su--estio%s 'or Class A$tivities
1( Resear$h A$tivity
)s( students to loo( up three companies in the ?oney M 3n'esting section of the -all .treet /ornal,
the financial pages of another newspaper, or on the 3nternet. Na'e them find the price%earnings ratio
of each company. -sing those data, ha'e them determine the rate of return on the mar(et 'alue of
shareholders, equity.
Su--estio%s&
"ose these questions*
1. What information does the rate of return pro'ideR
. Now is the information different from that pro'ided by the rate of return of shareholders, equity
as commonly calculated from financial statementsR
Poi%ts to %ote&
The rate of return on the mar(et 'alue of shareholders, equity is the in'erse of the price%earnings
ratio, i.e., the earnings%price ratio. The rate of return on the mar(et 'alue of shareholders, equity is a
summary measure of profitability. 3t measures the ability of management to generate earnings from
the resources that owners pro'ide. Oi(e other ratios, analysts must be careful not to 'iew it in
isolation Thats why its useful to supplement the return on shareholders equity ratio as commonly
calculated from financial statements (net income di'ided by a'erage shareholders, equity) with this
mar(et%based ratio. This ratio is simply the earnings per share di'ided by the mar(et price per share.
C( Real >orld S$e%ario
Hor*el )oods Cor,., which ma(es 1pam and other prepared foods, distributed a two%for%one stoc(
split in ?arch B11. )t the time the split was announced, the company,s stoc( price was G;A.
Su--estio%s&
)s( students to*
1. 1peculate as to why Normel declared the stoc( split.
. $onsider what the share price would be at the time of the distribution, other things being equal.
Poi%ts to %ote&
7ormally, as in this case, a split is made to reduce the per share price and thus enhance the
mar(etability of the stoc( by ma(ing it affordable to a larger number of potential in'estors. 3t also
might signal fa'orable performance. 5ther things equal, the new share price would be G;.=B after
the split. 5f course, quite a few circumstances and e'ents can cause the price to 'ary.
The McGraw-Hill Companies, Inc., 2013
1#-2) Intermediate $ccontin%, &e
D( Real >orld S$e%ario
4ollowing is a news release from 2eneral 0lectric*
4)3/430O+, $onn.%%(#-137011 W3/0)%%+ec. 1B, BB;%%The #oard of +irectors of 20 today
raised the $ompany,s quarterly di'idend 1BD to GB. per outstanding share of its common stoc( and
authori.ed the repurchase of up to G1= billion of its common stoc( o'er the ne&t three years.
C20 has tremendous prospects for growth in earnings and cash flow,C said 20 $hairman and $05
Peff 3mmelt.
CWe ha'e been e&ecuting a clear strategy to build a capital%efficient portfolio of faster%growth
industrial businesses and higher%returning financial ser'ices businesses,C 3mmelt said. CThat wor( is
now largely behind us, and we ha'e the best set of 20 businesses we,'e had in many years. We,re
confident that in BB= we will return to solid double%digit earnings growth with e&panding
incremental returns on capital and increasing cash flow from operating acti'ities. )s a result we fully
e&pect to ha'e the fle&ibility to in'est in technology and inno'ation while returning 'alue to
shareowners through a substantial di'idend and a share repurchase program.C
The di'idend increase, from GB.B per share, mar(s the Ath consecuti'e year in which 20 has
raised its di'idend. 20 has paid a di'idend e'ery year since 16AA. The di'idend is payable Panuary =,
BB=, to shareowners of record on +ecember @, BB;. The e&%di'idend date is +ecember .
The new share repurchase program replaces a program first authori.ed in 1AA;. 1ince 1AA;, 20
has returned more than G@= billion to shareowners through di'idends and the repurchase of more than
1.1 billion shares.
Su--estio%s&
)s( students to consider the statement that 20 has the 8fle&ibility to in'est in technology and
inno'ation while returning 'alue to shareowners through a substantial di'idend and a share
repurchase program.9 This implies a choice. What are the choicesR Now do the choices return 'alue
to shareholdersR
Poi%ts to %ote&
$ompanies ha'e choices regarding the disposition of earnings. 5ne choice is to rein'est in profit%
ma(ing acti'ities, hopefully benefiting shareholders through higher future earnings and therefore
future capital gains and di'idends. )nother choice is to distribute the earnings currently as di'idends.
)nother is to buy bac( shares. This supports the mar(et price of stoc( and reduces dilution that
occurs when new shares are issued.
The McGraw-Hill Companies, Inc., 2013
Instrctors! "esorce Manal 1#-2*
E( Real >orld S$e%ario
4ollowing is a news release from 7ortheast $ommunity #ancorp*
Northeast Co**u%ity !a%$or,I I%$( 9NAS.A3& NEC!) today announced that its #oard of
+irectors declared an initial quarterly cash di'idend of GB.B: per common share. The di'idend
will be paid on or about 7o'ember 1= to stoc(holders of record as of the close of business on
5ctober 1.
Su--estio%s&
)s( students to*
1. $onsider the effect on the share price on the e&%date, other things being equal.
. $onsider the ongoing effect of the decision on company assets, other things being equal.
:. 1peculate as to why 7ortheast $ommunity #ancorp declared the di'idend after not
pre'iously paying di'idends.
Poi%ts to %ote&
7ormally, the stoc( price declines by the amount of a cash di'idend, G.B: in this case, the first
day the stoc( trades after the recipients of the di'idend are determined. +i'idends use cash that
otherwise would be a'ailable for rein'estment in company growth or other acti'ities.
$ompanies typically pay cash di'idends when they feel that is a better return to shareholders
than would be rein'esting with the e&pectation of higher future stoc( prices. +i'idend decisions
reflect managerial strategy concerning the mi& of internal 'ersus e&ternal financing, alternati'e
in'estment opportunities, and industry conditions. Nigh di'idends often are found in mature
industries and low di'idends in growth industries. ?icrosoft, for instance, li(e 4ed0&
pre'iously, for years paid no di'idends, focusing instead on plowing a'ailable cash into growth
opportunities.
The McGraw-Hill Companies, Inc., 2013
1#-2+ Intermediate $ccontin%, &e
G( Professional Skills Development Activities
The following are suggested assignments from the end%of%chapter material that will help your
students de'elop their communication, research, analysis, and !udgment s(ills.
Co**u%i$atio% S/ills( )nalysis $ase 16%, 0&ercise 16%:, and "roblem 16%> are suitable for
student presentation(s). 3n addition to $ommunication $ases 16%: and 16%>, /esearch $ase 16%
; can be adapted to as( students to prepare a memo to the $ontroller outlining the findings of
the research. $ommunication $ases 16%: and 16%1B requires group interaction. "roblem 16%1
and )nalysis $ase 16%@ do well as group assignments. Suestions 16%11, 16%1, 0&ercise 16%1;,
and /esearch $ase 16%1B create good class discussions.
Resear$h S/ills( 3n their professional li'es, our graduates will be required to locate and e&tract
rele'ant information from a'ailable resource material to determine the correct accounting
practice, perhaps identifying the appropriate authoritati'e literature to support a decision. 3n
addition to /esearch $ase 16%;, $ommunication $ases 16%: and 16%1B pro'ide an e&cellent
opportunity to help students de'elop this s(ill. 3n addition, Pudgment $ase 16%= can be adapted
to require students to research the authoritati'e literature on accounting for stoc( splits.
A%alysis S/ills( The 8#roaden Tour "erspecti'e9 section includes )nalysis $ases that direct
students to gather, assemble, organi.e, process, or interpret date to pro'ide options for ma(ing
business and in'estment decisions. 3n addition to )nalysis $ases 16% and 16%@, 0&ercise 16%1,
"roblem 16%@, and /eal World 16%11 also pro'ide opportunities to de'elop analysis s(ills.
"ud-*e%t S/ills( The 8#roaden Tour "erspecti'e9 section includes Pudgment $ases that require
students to critically analy.e issues to apply concepts learned to business situations in order to
e'aluate options for decision%ma(ing and pro'ide an appropriate conclusion. 3n addition to
Pudgment $ase 16%=, $ommunication $ase 16%: also requires students to e&ercise !udgment.
The McGraw-Hill Companies, Inc., 2013
Instrctors! "esorce Manal 1#-2&
H( Ethi$al .ile**a
The chapter includes the following ethical dilemma.
ETHICAL .ILE11A
3nterworld +istributors has paid quarterly cash di'idends since 1A6=. The di'idends ha'e
steadily increased from G.= per share to the latest di'idend declaration of G.BB per share. The
board of directors is eager to continue this trend despite the fact that re'enues fell significantly
during recent months as a result of worsening economic conditions and increased competition. The
company founder and member of the board proposes a solution. Ne suggests a =D stoc( di'idend
in lieu of a cash di'idend to be accompanied by the following press announcement*
C3n lieu of our regular G.BB per share cash di'idend, 3nterworld will distribute a =D stoc(
di'idend on its common shares, currently trading at G;B per share. $hanging the form of the
di'idend will permit the $ompany to direct a'ailable cash resources to the moderni.ation of
physical facilities in preparation for competing in the 1st century.C
What do you thin(R
Tou may wish to discuss this in class. 3f so, discussion should include these elements*
Ste, 1 + The )a$ts&
The founder of 3nterworld +istributors suggests distributing a =D stoc( di'idend in lieu of its
regular G.BB per share cash di'idend. The board of directors wants to continue pro'iding di'idends
to shareholders despite the fact that re'enues ha'e recently declined. The stoc( di'idend will permit
3nterworld to conser'e cash and rein'est cash resources in moderni.ation of physical facilities.
1hareholder percentage of ownership in the company does not change as a result of a small stoc(
di'idend. +istribution of a small stoc( di'idend results in a reclassification of retained earnings to
paid%in capital. /etained earnings are reduced !ust as if a cash di'idend had been paid. "er share
stoc( prices usually decline after a company issues a small stoc( di'idend in order to maintain the
same o'erall 'alue of in'estment in the company. The company founder is attempting to produce the
illusion that current shareholders will be recei'ing a real di'idend and camouflage the fact that
re'enues ha'e declined.
Ste, C + The Ethi$al Issue a%d the Sta/eholders&
The ethical issue or dilemma is whether the boards obligation to protect the companys image
(and perhaps their !obs) is greater than its obligation to protect in'estors and creditors interests by
pro'iding full disclosure of rele'ant information.
1ta(eholders include the founder of 3nterworld, other members of the board of directors,
company management, employees, current and future creditors, and current and future in'estors.
Ste, D + #alues&
<alues include honesty, integrity, ob!ecti'ity, loyalty to the company, loyalty to shareholders, and
responsibility to users of financial statements.
The McGraw-Hill Companies, Inc., 2013
1#-2# Intermediate $ccontin%, &e
Ste, E + Alter%atives&
1. +istribute and record a =D stoc( di'idend to current holders of common stoc(.
. +o not declare a stoc( di'idend.
Ste, G + Evaluatio% o' Alter%atives i% Ter*s o' #alues&
1. )lternati'e 1 illustrates loyalty to protecting the company image to current shareholders.
, )lternati'e reflects 'alues of honesty, integrity, ob!ecti'ity, and responsibility for fair
reporting to current shareholders and to other users of the financial statements.
Ste, H + Co%seque%$es&
$lternative 1
"ositi'e consequences* The company and its management may loo( better in the eyes of some
shareholders. The company reser'es cash to in'est in the future moderni.ation of plant facilities.
7egati'e consequences* 1ome shareholders may falsely belie'e they are recei'ing a distribution of
'alue from the company. -sers of the financial statements would be misinformed. The founder and
the board may lose the respect of some shareholders and the financial community.
$lternative 2
"ositi'e consequences* The founder and board members maintain self%respect and gain the
respect of the financial community. -sers of the financial statements are better informed regarding
the true financial position of the company.
7egati'e consequences* 1hareholders become displeased about the lac( of di'idend distribution
and rein'est elsewhere. The stoc( price per share may decline due to the lac( of a di'idend
distribution. 1ome managers !obs may be in !eopardy.
Ste, B + .e$isio%&
1tudent(s) must decide their course of action.
The McGraw-Hill Companies, Inc., 2013
Instrctors! "esorce Manal 1#-2,
Assi-%*e%t Chart Assi-%*e%t Chart
Lear%i%- Est( ti*e
3uestio%s O0Je$tive9s; To,i$ 9*i%(;
16%1 1 1ources of shareholders equity =
16% 1 1ources of shareholders equity =
16%: 1 1ources of shareholders equity =
16%; 1 1ources of shareholders equity =
16%= 1 1ources of shareholders equity =
16%> 1 1ources of shareholders equity =
16%@ 1 1ources of shareholders equity =
16%6 1 1ources of shareholders equity =
16%A 1 1ources of shareholders equity =
16%1B 1 1ources of shareholders equity =
16%11 1 1ources of shareholders equity =
16%1 $omprehensi'e income =
16%1: $omprehensi'e income =
16%1; : 1tatement of shareholders, equity =
16%1= ; 1hares sold for consideration other than cash =
16%1> ; ?ore than one security sold for a single price =
16%1@ ; 1hare issue costs =
16%16 = When shares are retired =
16%1A = Treasury shares =
16%B 6 1toc( di'idends =
16%1 6 1toc( splits =
16% 6 /e'erse stoc( split =
16%: 6 1toc( di'idends =
16%; ) Suasi%reorgani.ation =
The McGraw-Hill Companies, Inc., 2013
1#-30 Intermediate $ccontin%, &e
!rie' Lear%i%- Est( ti*e
E2er$ises O0Je$tive9s; To,i$ 9*i%(;
16%1 $omprehensi'e income =
16% ; 1toc( issued =
16%: ; 1toc( issued =
16%; ; 1toc( issued =
16%= ; 0ffect of preferred stoc( on di'idends =
16%> = /etirement of shares =
16%@ = /etirement of shares =
16%6 = Treasury stoc( =
16%A = Treasury stoc( =
16%1B = Treasury stoc( =
16%11 @ $ash di'idend =
16%1 @ "roperty di'idend =
16%1: 6 1toc( di'idend =
16%1; 6 1toc( split =
16%1= 6 1toc( split =
16%1> A 34/1E reporting shareholders equity =
The McGraw-Hill Companies, Inc., 2013
Instrctors! "esorce Manal 1#-31
Lear%i%- Est( ti*e
E2er$ises O0Je$tive9s; To,i$ 9*i%(;
16%1 $omprehensi'e income =
16%
FASB codifcation research; reporting other
comprehensi'e income in shareholders equity
1=
16%:
Earnings or OCI?
1=
16%; ; 1toc( issued for cashE >ri-ht 1edi$al rou, 1=
16%= ; 3ssuance of sharesE noncash consideration B
16%> ; /edeemable shares 1=
16%@ ; 1hare issue costsE issuance 1=
16%6 ; /eporting preferred shares 1=
16%A ; 7ew equity issuesE offerings announcements 1=
16%1B ;
0ffect of cumulati'e, nonparticipating preferred
stoc( on di'idends : years
1=
16%11 = /etirement of shares 1=
16%1 = /etirement of shares B
16%1: = Treasury stoc( 1=
16%1; = Treasury stoc( weighted a'erage and 4345 cost B
16%1= = /eporting shareholders equity B
16%1> = $hange from treasury stoc( to retired stoc( B
16%1@ = 1toc( buybac(E press releaseE .uPo%t 1=
16%16 >, @ Transactions affecting retained earnings =
16%1A 6 1toc( di'idend 1B
16%B 6 1toc( splitE Ha*%i )i%a%$ial 1=
16%1 6 $ash in lieu of fractional share rights 1=
16% 1, =, 6 4)1# codification research 1=
16%: >, @, 6 Transactions affecting retained earnings :=
16%; 1 "rofitability ratio 1=
16%= A 34/1E equity terminology 1=
CPA?C1A Lear%i%- Est( ti*e
E2a* 3uestio%s O0Je$tive9s; To,i$ 9*i%(;
$")%1 = /etirement of shares :
$")% = Treasury stoc( :
$")%: @ "roperty di'idend :
$")%; @ 1toc( di'idend :
$")%= 6 1toc( di'idend :
$")%> 6 1toc( split :
$")%@ A 34/1 :
$")%6 A 34/1 :
$?)%1 1 $ommon stoc( :
$?)% 1 $ommon stoc( :
$?)%: 6 1toc( di'idend :
The McGraw-Hill Companies, Inc., 2013
1#-32 Intermediate $ccontin%, &e
Lear%i%- Est( ti*e
Pro0le*s O0Je$tive9s; To,i$ 9*i%(;
16%1 ; <arious stoc( transactionsE correction of !ournal
entries
=
16% = 1hare buybac( comparison of methods :=
16%: = /eacquired shares comparison of retired
shares and treasury shares
:B
16%; =, @ 1tatement of retained earnings =
16%6 :,
;, @
1hare issue costsE issuanceE di'idendsE early
retirement
1=
16%A @ 0ffect of preferred stoc( characteristics on
di'idends
1=
16%1B ;%6 Transactions affecting retained earnings B
16%11 6 3n'estment in debt securitiesE integrati'e
problem
B
16%1: ) Suasi%reorgani.ation
Fbased on )ppendi& 16H
=
The McGraw-Hill Companies, Inc., 2013
Instrctors! "esorce Manal 1#-33
16%= >, @, 6 1hareholders equity transactionsE statement of
shareholders, equity
=B
16%> 1, :%6 1tatement of shareholders, equity :=
16%@ 1%; /eporting shareholders, equity* comprehensi'e
incomeE Cis$o Syste*s
:=
16%1 1, ;%6 <arious shareholders equity topicsE
comprehensi'e
>=
1tar "roblems
Lear%i%- Est( ti*e
Cases O0Je$tive9s; To,i$ 9*i%(;
/eal World $ase 16%1 ; 3"5E .ol0y La0s 1B
)nalysis $ase 16% 1, :, >, @ 1tatement of shareholders, equity :=
$ommunication $ase 16%: 1
3s preferred stoc( debt or equityR group
interaction
:B
/esearch $ase 16%; $odification researchE comprehensi'e incomeE
researchE integrati'eE Cis$o
B
Pudgment $ase 16%= =%6 Treasury stoc(E stoc( splitE di'idendsE Al$oa 1=
$ommunication $ase 16%> ; 3ssuance of sharesE share issue costsE prepare a
report
;=
)nalysis $ase 16%@ 1
)naly.ing financial statementsE price%earnings
ratioE di'idend payout ratio
:B
0thics $ase 16%6 ;
The 1wiss label ma(erE 'alue of shares issued
for equipment
=
/esearch $ase 16%A 1, >
/esearching the way shareholders equity
transactions are reportedE retrie'ing financial
statements from the 3nternet
=B
$ommunication $ase 16%1B 1 1hould the present two%category distinction
between liabilities and equity be retainedR group
interaction
:B
Air )ra%$e?<L1 Case
A 34/1E reporting shareholders equityK Air
)ra%$e?<L1
:B
CPA Si*ulatio% 18+1 PudgmentE stoc( di'idends and splitsE
di'idends on preferred stoc(E treasury stoc(E
manditorily redeemable preferred stoc(
The McGraw-Hill Companies, Inc., 2013
1#-3) Intermediate $ccontin%, &e