Chapter 15 PDF

INTERMEDIATE
ACCOUNTING
Chapter 15
Contributed Capital
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or in part.
Objectives
1. Define equity and explain the corporate form of

organization, including its advantages and
disadvantages.
2. Know the rights and terms that apply to capital
stock.
3. Account for the issuance of capital stock.
4. Describe noncompensatory share purchase plans.
5. Describe and account for share-based compensation
plans.
6. Describe the characteristics of preferred stock.
7. Understand the accounting for treasury stock.
8. Know the components of contributed capital and how
they are reported in financial statements.
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible webs ite, in
whole or in part.
What Information Does
Shareholders’ Equity Provide? (Slide 1 of
2)
 Equity is the residual interest in the assets

of a company that remains after deducting its
liabilities.
 The balance sheet accounting for financing
activities by common equity shareholders
typically involves:
 Contributed capital accounts, such as common equity
at par and additional paid-in capital
 Contributed Capital
 Earned capital is, the
accounts such section of earnings
as retained
shareholders’
and accumulatedequity in which a corporation
other comprehensive income
records the results of all its stock
transactions in capital stock accounts and
additional paid-in capital accounts.
whole or in part.
What Information Does
Shareholders’ Equity Provide? (Slide 2 of
2)
 Retained Earnings is an account in shareholders’

equity where any net income that has been reinvested in
the corporation and not paid out to shareholders as
dividends is reported.
 Accumulated Other Comprehensive Income is an account
in shareholders’ equity where a corporation reports any
increase or decrease in shareholders’ equity as a
result of other comprehensive income.
 A company’s equity changes:
 As it earns net income
 As it declares dividends
 As transactions between the company and its owners occur
 As other comprehensive income transactions occur
whole or in part.
Changes in Equity Accounts
whole or in part.
How Are Corporations Organized?
 Shareholders (or stockholders) are owners of a

corporation.
 The primary advantage of the corporate form is the
ability to raise large amounts of capital by
issuing shares of stock.
 Limited legal liability is a concept in which
owners bear no personal liability for the
corporation’s debts and risk; they risk only
their capital investment.
 Corporations generally pay more taxes than other
organization forms because of:
 Higher tax rates than other forms
Owners
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How Are Corporations Classified?
(Slide 1 of 2)
 Privately held corporations are any

corporations not owned by the government.
 Open corporations (often called publicly traded
corporations) are corporations whose stock can
be purchased by any individual on a stock
exchange.
 Closed corporations (often called privately
held corporations) are corporations that do not
allow the sale of stock to the general public.
For example, the candy company Mars, Inc.
 Public corporations are corporations owned
or operated by governmental units.
whole or in part.
How Are Corporations Classified?
(Slide 2 of 2)
 Domestic corporations are companies doing

business in the state in which it is
incorporated.
 Starbucks, which is incorporated in the State of
Washington, is a domestic company with respect to
Washington.
 Walmart is a domestic corporation with regard to
the State of Arkansas.
 Foreign corporations are companies that are
operated in a state other than the one in
which it is incorporated.
 Starbucks is a foreign corporation with regard to
whole or in part.the State of North Carolina.
How Are Corporations Formed?
 In the United States, a corporation is a legal

entity of a particular state.
 An approved application for incorporation becomes
a corporation’s articles of incorporation (or
corporate charter).
 For a corporation to perform its functions, the
state gives it various rights and powers. These
include the right to:
 Enter into contracts
 Hold, buy, and sell property
 Sue and be sued
 Continue indefinitely
whole or in part.
How is the Capital Structure
of a Corporation Defined?
 A stock certificate is a serially numbered
document that indicates the number of shares
owned and the par value (if any).
 Because stock certificates are easily transferred
from one investor to another, state laws require
that each corporation keep appropriate records of
its shareholders.
 A transfer agent (such as a bank) handles the
issuance of stock certificates.
 A registrar is a person who maintains the
shareholder records.
whole or in part.
Capital Stock and Shareholders’
Rights
(Slide 1 of 2)
 Capital stock refers to the shares of stock

issued by the corporation and owned by its
shareholders.
 Each shareholder has various rights.
 Right to a dividend when it is declared
 Right to elect directors and to establish
corporate policies (voting right)
 Right (called a preemptive right) to maintain a
proportionate interest in the ownership of the
corporation by purchasing a proportionate (pro
rata) share of additional capital stock if more
stock is issued
 Right to share in the distribution of the assets of the
whole or in part.
Capital Stock and Shareholders’
Rights
(Slide 2 of 2)
 Common stock is capital stock that carries

all of the rights of ownership.
 Some corporations issue more than one class
of common stock such as Class A and Class B
common stock.
 In this case, usually one type of common
stock has greater voting rights than the
other to maintain control over the corporate
activities.
 Preferred stock is not granted all of the
common stock’s rights, but receives in
exchange certain other privileges.
whole or in part.
Basic Terminology
 Authorized capital stock is the number of shares of

capital stock (both preferred and common) that a
corporation may issue as stated in the corporate charter.
 Issued capital stock is the number of shares of capital
stock that a corporation has issued to its shareholders as
of a specific date.
 Outstanding capital stock is the number of shares of
capital stock that a corporation issued to stockholders
and that are being held by shareholders as of a specific
date.
 Treasury stock is the number of shares of issued capital
stock reacquired from shareholders, but not retired.
 Subscribed capital stock is the number of shares of
capital stock that a corporation will issue upon
whole or in completion of an installment purchase contract with an
part.
Legal Capital
(Slide 1 of 2)
 To protect the corporation’s creditors,

state laws have established the concept
of legal capital as the amount of
stockholders’ equity that the corporation
cannot distribute to shareholders.
 The definition of legal capital varies
among states.
 Most states designate that the par value of
all its issued stock is the legal capital.
whole or in part.
Legal Capital
(Slide 2 of 2)
 The par value of a corporation’s capital stock (either

common or preferred) is a designated dollar amount per
share that is established in the articles of
incorporation and is printed on each stock
certificate.
 The par value of a stock has no relation to its market
value.
 Stock rarely sells initially for less than its par value,
because it is illegal to do so in most states.
 No-par capital stock is stock that does not carry a
par value. When a corporation issues no-par stock,
some states require that the corporation designate the
entire proceeds received as legal capital.
 Stated value per share of no-par stock, when
whole or in multiplied
part. by the number of shares issued, generally
Additional Paid-in Capital
 State law requires the corporation to record

the par or stated value.
 Additional paid-in capital is the excess value
received (the difference between the exchange
price and the par or stated value) in each
type of stock transaction.
 While most companies use the term Additional
Paid-in Capital, you may also see the terms:
 Capital in Excess of Par (or Stated) Value

 Paid-in Capital in Excess of Par (or Stated)
Value
whole or in part.
How Do We Account for the Issuance
of Capital Stock? (Slide 1 of 2)
 When a corporation issues only one class of
capital stock, it is referred to as common
stock.
 The corporate charter contains the authorization
to issue capital stock. This authorization is
recorded in a memorandum journal entry which
identifies the number of authorized shares, the
par or stated value, and, in the case of
preferred stock, any preferred provisions.
 Example (Issuance for Cash) Powell Corporation
issues 500 shares of its $5 par common stock for
$16 per share. The corporation’s journal entry
for the issuance of stock is shown on the next
whole or in part.
How Do We Account for the Issuance
of Capital Stock? (Slide 2 of 2)
Cash ($16 × 500) 8,000
Common Stock, $5 par value ($5 × 500) 2,500
Additional Paid-in Capital on Common Stock 5,500
 If the stock were no-par stock with a stated value
of $5 per share, the corporation would record the
preceding transaction as follows:
Cash 8,000
Common Stock, $5 stated value ($5 × 500) 2,500
 For both situations, the number of shares issued

can be determined as follows:
Total Amount in the Common Stock Account
Number of Shares Issued =
Par or Stated Value of the Shares
whole or in part.
Combined Sales of Stock
(Slide 1 of 2)
 When a corporation issues different types of

securities in a combined sale, it allocates the
proceeds between the securities based on the
relative fair value of each security.
 If the fair value of only one of the securities are
known, the fair value amount is assigned to that
security. The remaining proceeds are assigned to the
security with the unknown fair value.
 Example Brandt Corporation issues 100 “bundles” of
securities for $82.80 per bundle, or a total of
$8,280.
 Each bundle includes two shares of $10 par common stock
and one share of $50 par preferred stock.
 If the separate fair values are $16 per share for the
whole or in part.
(Slide 2 of 2)
 Brant makes the following journal entry:

Cash 8,280
Common Stock, $10 par (200 shares) 2,000
Additional Paid-in Capital on Common Stock 880
Preferred Stock, $50 par (100 shares) 5,000
Additional Paid-in Capital on Preferred Stock 400
Supporting Computations:
Aggregate Fair Value
Common Stock: $16 × 2 shares × 100 packages = $3,200
Preferred Stock: $60 × 1 share × 100 packages =
6,000
Allocation
$3,200 $9,200
Common Stock: × $8,280 = $2,880
$9,200
$6,000
Preferred × $8,280 = 5,400
Stock: $9,200 $8,280
whole or in part.
Stock Issuance Costs
 A corporation may incur miscellaneous costs

that arise from issuing its capital stock.
 Legal fees
 Accounting fees
 Stock certificate fees

 Underwriter’s fees
 Promotional fees
 Postage
 When these costs are incurred at the initial
issuance of stock at the time of
incorporation, they are considered an
organization expense.
whole or in part.
Stock Subscriptions
 Investors sometimes agree to purchase

capital stock from a corporation and pay at
a later date.
 This creates a legally-binding subscription
contract between the corporation and the future
shareholders.
 This contract requires the investor to buy a
certain number of shares at an agreed-upon
price, with payment spread over a specified time
period.
 The contract often requires a down payment and
may require the investor to issue the company a
promissory note.
whole or in part.
(Slide 2 of 2)
Cash ($16 × 500) 8,280

Common Stock, $10 par (200 shares) 2,000
Additional Paid-in Capital on Common Stock 880
Preferred Stock, $50 par (100 shares) 5,000
Additional Paid-in Capital on Preferred Stock 400
Supporting Computations:
Common Stock: $16 × 2 shares × 100 packages =$3,200
Preferred Stock: $60 × 1 shares × 100 packages = 6,000
$9,200
Allocation
Common Stock: ($3,200 ÷ $9,200) × $8,280 = $2,880
Preferred Stock: ($6,000 ÷ $9,200) × $8,280 = 5,400
$8,280
The $5,400 allocated to Preferred Stock is calculated
whole or in part.
likewise.
Nonmonetary Issuance of Stock
(Slide 1 of 2)
 A nonmonetary exchange is any type of transaction in

which a corporation issues capital stock for assets
other than cash, or for services performed.
 The general rule is to record the exchange at the
fair value of the stock issued or the asset received,
whichever can be measured with greater
representational faithfulness.
 Example (Fair Value of Stock Known) Capers
Corporation issues 200 shares of $10 par common stock
for a patent. The stock is currently selling for $22
per share
Patent ($22on× the
200) open market. Caper records the
4,400
Common transaction:
following Stock, $10 par 2,000
whole or in part.
Nonmonetary Issuance of Stock
(Slide 2 of 2)
 Stock may be closely held and not actively

traded. The fair value of the assets received
may provide a more representationally faithful
value of the transaction.
 Example (Fair Value of Asset Known) Eli
Corporation issues 500 shares of $8 par common
stock that is not widely traded for an acre of
land.
 An independent appraiser indicates the land is worth
Land
$20,000. 20,000
The transaction would be recorded as follows:
Common Stock, $8 par 4,000
whole or in part.
Stock Splits
(Slide 1 of 2)
 To reduce the market price of a corporation’s

stock so that it falls within a desired
“trading range” of most investors, a
corporation may authorize a stock split.
 A stock split is proportionally decreases in
market price and par value per share of stock
and increases the number of shares issued.
 A stock split also results in a proportional
increase in the number of shares authorized.
 A reverse split increases the par value per
share and proportionally decreases the number
of shares issued.
whole or in part.
Stock Splits
(Slide 2 of 2)
 Example Ollar Corporation has 250,000

authorized shares and has issued 60,000 shares
of $10 par common stock.
 Ollar declares a two-for-one stock split with a
reduction to a $5 par value.
 After the split, 500,000 shares are authorized,
and a total of 120,000 shares of $5 common stock
are issued.
 A corporation ordinarily records a stock split
by a memorandum entry that indicates the new
par value, the total number of shares issued,
and the impact (if any) on the number of
authorized shares.
whole or in part.
Stock Warrants
(Slide 1 of 3)
 Stock warrants represent the right to purchase additional

shares of common stock at an established price, usually
referred to as the exercise price.
 Exercise price (or strike price) is the price at which
the holder of an option or warrant has the right to buy
or sell the common stock.
 Detachable warrants are warrants that can be separated
from the other security and traded independently.
 Example Rehage Company issues 1,000 shares of $50 par
preferred stock with detachable warrants for $106,000 on
January 1, 2013.
 Each share of preferred stock is issued with 5 detachable
warrants. Each warrant entitles the holder to purchase one
share of common stock for $50. The warrants expire in 2 years.
whole or in part.
Stock Warrants
(Slide 2 of 3)
 The fair market value of the preferred stock is

$72,000 on January 1, 2013, and the warrants sell for
$8 per warrant. Rehage makes the following journal
entry:
Cash 106,000.00
Preferred Stock 50,000.00
Additional Paid-in Capital on
Preferred Stock 18,142.86
Paid-in Capital—Common Stock
Warrants 37,857.14
Preferred Stock $ 72,000
Common Stock Warrants = 5,000 warrants × $8 = 40,000
$112,000
Allocation
Preferred Stock ($72,000/$112,000) × $106,000 = $68,142.86
Common Stock Warrants ($40,000/$112,000) × $106,000 = $37,857.14
whole or in part.
Stock Warrants
(Slide 3 of 3)
 On July 1, 2016, the warrants are exercised to

purchase common stock (with a par value of $10 per
share). The exercise price is $50 per share. Rehage
should make the following entry:
Cash (5,000 warrants × $50) 250,000.00
Paid-in Capital—Common Stock Warrants 37,857.14
Common Stock (5,000 × $10 par
value) 50,000.00
Additional Paid-in Capital on Common
Stock 237,857.14
 When the warrants are exercised, the Paid-in Capital—
Common Stock Warrants account is eliminated.
Consideration = Cash of $250,000 + Warrants valued at
$37,857.14
whole or in part.
How Do Companies Account for
Noncompensatory Share Purchase Plans?
 A noncompensatory share purchase plan enables employees
to buy shares of stock, usually at a discount.
 Three criteria for share purchase plan to be
noncompensatory:
 All employees who meet limited employment qualifications may
participate in the plan on an equal basis.
 The discount from the market price does not exceed the per-
share amount of stock issuance costs avoided by not issuing
the stock to the public.
 The plan has no option features other than the following:
 Employees are allowed a short time (no longer than 31 days)
from the date the purchase price is set to decide whether to
enroll in the plan
 The purchase price is based solely on the market price of the
stock on the purchase date, and employees are permitted to
whole or in part. cancel their participation before the purchase date and obtain
What Are Share-Based Compensation
Plans?
 A share-based compensation plan is a compensation
arrangement in which employees receive share
options, shares of stock, or cash payments based on
the change in stock price instead of cash bonus.
 A compensatory share option plan is an arrangement
intended to provide additional compensation by
rewarding employees shares in the company or cash
bonuses tied to changes in the company’s stock
price.
 Restricted share awards and appreciation rights are
arrangements intended to provide additional

compensation by awarding employees shares in the
company or cash bonuses tied to changes in the
company’s
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not be scanned, copied or duplicated, or posted to a publicly accessible webs ite, in
whole or in part.
Overview of Compensatory
Share Option Plans
 In developing a compensatory share option
plan, a company’s objective is to better align
the company’s goals with those of management
and its owners.
 The grant date is the date on which the
company provides the share options to the

employees.
 The intrinsic value method is a method whereby
a corporation measures theMarket total options-based
Price Exercise
Total Options- Number of
compensation
Based Compensation
= cost for each
Share Options
× of employee
the Stock ‒ as
Price of the
Costfollows: on Date of Share Option
Grant
whole or in part.
Accounting for Share-Based
Compensation Plan
 In response to the need for high-quality
“transparent” financial reporting, the FASB
updated the accounting for share-based
compensation plan to require the use of the fair
value method. Below you see the “big picture.”
whole or in part.
How Do We Account for Compensatory
Share Option Plans? (Slide 1 of 4)
 Option pricing models are used to estimate the
fair value of the option.
 The option pricing model that a corporation uses
must take into account the following variables as
of the grant date:
 Exercise price
 Expected life of the option
 Current market price of the underlying common stock
 Expected volatility of the stock price
 Expected dividends on the stock
 Risk-free interest rate for the expected term of the
 An option
option’s value is determined at the grant date as
follows:
Option Value (Fair Value) = Current Stock Price ‒ Present Value of
Exercise Price
whole or in part.
 The cost recognized by a company for its share-based
compensation plan is the total fair value of the
share options that actually become vested.
 Vested occurs when an employee has fulfilled the
service requirement and has ownership of the share
options.
 If the corporation expects that a significant number
of employees will forfeit their options, then it
records the compensation expense each year based on
an estimate of the number of options expected to
vest. The estimated total compensation cost is
determined at the Fair
Estimated Total grant date as
Value follows:
Estimate of the Number of
= ×
Compensation Cost per Option Share Options Expected to
Vest
whole or in part.
 A fixed share option plan is a plan in which all the
terms (e.g., exercise price, number of shares) are set
(“fixed”) on the grant date.
 Example On January 1, 2013, Fox Corporation
adopts a compensatory share option plan and
grants 9,000 share options (to acquire 9,000
shares of common stock) with a maximum life of
10 years to 30 selected employees.
 The $50 exercise price is equal to the market price
of the stock on this grant date. All the options
vest at the end of 3 years if the employee is still
employed by the company.
 Fox expects 10% of the options to be forfeited.
whole or in part.
 At the end of 2015, a total of 7,500 share options
for 25 employees actually vest, and the other 1,500
are forfeited. Fox determines that the fair value
of each option is $18 on the grant date.
 The total options-based estimated compensation cost
on the grant date for this fixed share option plan
is determined as follows:
Total Options-Based = Fair Value × Number of Options
Estimated Compensation Cost per Option Expected to Vest
= $18 × (9,000 ×
.09)
 On January 1, 2013 (the =grant

$145,800
date), Fox makes a
memorandum entry to summarize the terms of the
compensatory share option plan.
whole or in part.
Fixed Compensatory Share Option Plan
Fox Corporation
whole or in part.
Performance-Based Option Plans
(Slide 1 of 2)
 Performance-based share option plans (or variable-

term share option plans) are plans in which one or
more terms are not fixed at the grant date. These
plans are set up so that the terms will vary
depending on how well the selected employees perform
during the service period.
 Example The terms of Fox Corporation’s performance-
based plan adopted on January 1, 2013, are the same
as in the previous example (3-year vesting and
service period, $50 exercise price, and $18 fair
value per option) except, Fox grants each of the 30
selected employees a minimum of 300 share options.
 The options vest in differing numbers depending on the
market share of Fox’s products over the 3-year
whole or in part. period.
Performance-Based Option Plans
(Slide 2 of 2)
 Terms of the plan are that by December 31, 2015:

 If the market share has increased by at 5%, at least
100 share options will vest for each employee on
that date.
 If the market share has increased by at least 10%,
another 100 share options will vest for each
employee, for a total of 200.
 If the market share has increased by more than 20%,
 Atallthe
300end
share
of options will
2015, Fox vest for each
determines thatemployee.
its market
share has increased over the 3-year period by more
than 20%. In addition, at the end of 2015, 25
employees vest in 7,500 share options.
whole or in part.
Performance-Based Compensatory
Share Option Plan
Fox
Corporation
whole or in part.
Restricted Share Plan
(Slide 1 of 4)
 Because some employees who qualify to buy shares

of stock in a compensatory plan have a cash-flow
problem, corporations have developed share-based
plans involving restricted shares.
 A restricted share plan is a plan in which employees
are granted actual shares of stock.
 While the employee becomes an actual shareholder on
the date of the grant, the company maintains physical
possession of the shares, restricting the employee’s
ability to sell the shares until the employee reaches
certain goals.
 These restrictive shares are referred to as
noninvested shares.
whole or in part.
(Slide 2 of 4)
 Compensation cost for restricted share plans is

determined using the fair value method and is
calculated as follows:
Total Compensation Market Price of the Number of Restricted
Cost = Share on Date of Grant × Shares Awarded
 Example On January 3, 2013, Taos Corporation hires
a new Director of Accounting.
 In addition to salary and other benefits, the
employment package grants 10,000 restricted shares of
Taos common stock that vest in 3 years if the director
is still an employee.
whole or in part.
(Slide 3 of 4)
 On January 3, 2013, the $5 par value common stock is

trading at $63 per share. The restricted share award is
calculated below:
Total Compensation Market Price of the Number of Restricted
Cost = Share on Date of Grant × Shares Awarded
$630,000 = $63
× 10,000 share units
 Taos would recognize $210,000 ($630,000 ÷ 3 years) of
compensation expense for each of the three required
years as follows:
December 31, 2013
Compensation Expense 210,000
Paid-in Capital from Restricted Shares 210,000
 If the Director of Accounting is still an employee at
the end of 3 years, the shares would vest and no
longer
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All Rights restricted.
May not be scanned, copied or duplicated, or posted to a publicly accessible webs ite, in
whole or in part.
(Slide 4 of 4)
 Taos would issue 10,000 common shares to the employee

as follows:
December 31, 2015
Common Stock (10,000 × $5 Par Value) 50,000
Additional Paid-in Capital from Common
Stock 580,000
 If the Director of Accounting left Taos on March 1,
2015, Taos would make the following journal entry to
reverse the 2 years of compensation expense previously
recorded.
March 1, 2015
whole or in part.
Share Appreciation Rights
(Slide 1 of 3)
 Share appreciation rights (SARs) are rights granted

to selected employees that enable them to receive
cash, shares, or a combination of both equal to the
excess of the market value over a stated price of
the corporation’s stock on the date of exercise.
 A company accounts for a SARs plan using the fair
value method.
 For SARs the fair value can only be determined on
the date the rights are exercised.
 To record the compensation expense for the SARs
plan, an estimate of the total compensation cost is
made at the end of each year based on the fair value
of the SARs at that time. Adjustments are made after
each service period has expired.
whole or in part.
Recognition of Compensation Cost
Under SAR
whole or in part.
(Slide 2 of 3)
 Example On January 1, 2013, when the market

price is $60 per share, Wolf Corporation
grants share appreciation rights to a
selected employee, Tom Essman.
 Under the SAR plan, Tom will receive cash for
the difference between the quoted market price
and $60 for 1,000 shares of Wolf’s common stock
on the date of exercise.
 The service period is 4 years and the rights
must be exercised within 10 years of the grant
date.
whole or in part.
(Slide 3 of 3)
 On the grant date, Wolf estimates that the fair

value of each SAR is $17. Wolf makes a
memorandum entry on January 1, 2013, indicating
that the estimated fair value of this SAR award
is $17,000.
 On December 31, 2013, the fair value per SAR is
$20.
 On that date, Tom exercises the rights when the
quoted market price of Wolf’s stock is $94 per
$20 x 1,000 shares = $20,000
share.
 Tom’s compensation is calculated:
 The necessary entry is shown under the exhibit on

whole or in part. the next slide.
SAR Annual Compensation Expense

SAR Compensation Payable 5,000
whole or in part.
Real Report: Disclosure of
Share-Based Compensation Plans (Slide 1
of 6)
whole or in part.
of 6)
whole or in part.
Real Report: Disclosure of Share-
Based Compensation Plans (Slide 3 of 6)
whole or in part.
Questions:
1. The market price of Starbucks shares
at the end of fiscal 2010 was $25.94
per share. Assuming that all of the
share (stock) options exercised
during fiscal 2010 were exercised at
year-end, what was the “profit” or
“loss” made by employees who
exercised their options in fiscal 2010?
During fiscal 2010, 9,600,000 options
were exercised at weighted average
exercise price of $11.94 per share. If
these options were exercised when the
price was $25.94, these employees
made a “profit” of $14.00 per share ($25.94 ‒ $11.94) or $134,400,000 (9,600,000
shares × $14 per share).
whole or in part.
of 6)
2. How many options are currently exercisable at the end of fiscal 2010? How
many shares does Starbucks have reserved for future grants under its share
option plan? At the end of fiscal 2010, 60,700,000 options were currently
exercisable at a weighted average price of $16.52, and Starbucks has 27.9
million shares of common stock available for issuance pursuant to future
equity-based compensation awards. Given that Starbucks granted 14.9
million awards in 2010, the amount reserved for future awards may need to
be increased in the near future.
3. How much compensation expense did Starbucks recognize during fiscal 2010
related to share-based awards? Starbucks recognized total compensation
expense of $113,600,000 in fiscal 2010. $76,800,000 of this total was related
to share options and $36,800,000 was related to restricted share units.
4. How did Starbucks determine the compensation expense related to share options?
Starbucks determined the fair value of the compensation expense based on
the fair value of the share-based awards computed using the Black-Scholes-
Merton model. (continued on next slide)
whole or in part.
Starbucks in the notes to the financial statements states that the Black-
Scholes-Merton model uses of the following assumptions:
• Expected term
• Expected stock price volatility
• Risk-free interest rate
• Expected dividend yield
whole or in part.
What Characteristics are Associated
with Preferred Stock?
 Various preferred stock characteristics may be
specified in preferred stock contract:
 Preference as to dividends
 Accumulation of dividends
 Participation in excess dividends
 Convertibility to common stock
 Attachment of stock warrants
 Callability by the corporation
 Mandatory redemption at a future maturity date
 Preference to assets upon liquidation of the
corporation
 Lack of voting rights
whole or in part.
Preference as to Dividends
 A corporation must pay any applicable dividends to

preferred shareholders before a dividend may be
paid to common shareholders.
 Example Trask Corporation has outstanding 2,000
shares of 8%, $100 par preferred stock.
 Each preferred shareholder is entitled to an $8
(8% × $100) annual dividend per share.
 The corporation must pay $16,000 of dividends
(8% × $100 × 2,000) to preferred stockholders before
it may pay any dividends to common shareholders.
 A preference as to dividends does not guarantee that
a corporation will pay a preferred dividend in any
given year.
whole or in part.
Cumulative Preferred Stock
(Slide 1 of 2)
 Noncumulative preferred stock is stock carrying

the provision that the holder will never be paid a
dividend in a particular year if dividends are not
declared in that year.
 Cumulative preferred stock is stock carrying the
provision that, if a corporation fails to declare
a dividend on cumulative preferred stock at the
stated rate on the usual dividend date, the amount
become dividends in arrears.
 Dividends in arrears accumulate from period to period.
 Dividends in arrears are not liabilities.
 A corporation cannot pay common shareholders any
dividends until it has paid the preferred dividends in
arrears.
whole or in part.
Cumulative Preferred Stock
(Slide 2 of 2)
 Example Richland Corporation has outstanding 1,000

shares of 10%, $100 par cumulative preferred
stock. Each share of stock is entitled to a $10
annual dividend (10% × $100 Par Value).
 If Richland does not pay dividends in 2013 and 2014,
preferred shareholders would be entitled to dividends
in arrears of:
$10,000 at the end of 2013 (1,000 shares × $10 per share)
$20,000 at the end of 2014 (1,000 shares × $10 per share × 2

years)
At the end of 2015, Richland would have to pay $30,000
(1,000 shares × $10 per share × 3 years) to preferred
stockholders before it could pay any dividends to
common stockholders.
whole or in part.
Participating Preferred Stock
 Participating preferred stock is stock

carrying the provision that preferred
shareholders share with the common
shareholders in any additional dividends.
 Participating preferred stock may be either
fully or partially participating.
 Fully participating preferred shareholders are
shareholders who share equally with the common
shareholders in any extra dividends.
 Partially participating preferred shareholders
are shareholders who share in extra dividends,
but the participation is limited to a fixed
rate or amount per share.
whole or in part.
Convertible Preferred Stock
(Slide 1 of 2)
 Convertible preferred stock is stock with a

provision that allows shareholders, at their
option and under specified conditions, to convert
the shares of preferred stock into another
security of the corporation.
 Accounting for the conversion of preferred to
common stock is very straightforward because the
book value method is used.
 Example Ness Corporation originally issued 500
shares of $100 par convertible preferred stock at
$120 per share.
 Each preferred share may be converted into four shares
of $20 par common stock and all shares are converted.
whole or in part.
Convertible Preferred Stock
(Slide 2 of 2)
 Ness makes the following journal entry at conversion:

Preferred Stock, $100 par 50,000
Additional Paid-in Capital on Preferred Stock10,000
Common Stock, $20 par (4 × 500 × $20) 40,000
Additional Paid-in Capital from Preferred
Stock Conversion ($60,000 ‒ $40,000) 20,000
If the total contributed capital eliminated for the

preferred stock is more than the common stock par
value, the corporation records the excess as an
increase in additional paid-in capital related to
the conversion.
 The conversion of preferred to common stock
changes the components of shareholders’ equity,
but does not affect the corporation’s total
shareholders’
© 2013 Cengage Learning. All Rights Reserved.equity.
May not be scanned, copied or duplicated, or posted to a publicly accessible webs ite, in
whole or in part.
Preferred Stock with Stock Warrants
(Slide 1 of 3)
 A corporation may also attach warrants to

preferred stock to enhance their attractiveness.
 These warrants represent rights that allow the
holder to purchase additional shares of common
stock at a specified price over some future
period.
 Because these warrants are detachable from the
preferred stock, they usually begin trading on the
stock market at some market price.
 The investor in detachable preferred stock has
dual rights:
 Right to dividends that will be paid on the preferred
stock
part.Right to the market value appreciation of the common
whole or in 
(Slide 2 of 3)
 Example Ponce Corporation issues 1,000 shares of

$100 par value preferred stock at a price of $121
per share.
 It attaches a warrant to each share of stock that
allows the holder to purchase one share of $10 par
common stock at $40 per share.
 Immediately after the issuance, the preferred stock
begins selling ex rights (without the rights attached)
on the market for $119 per share and the warrants
begin selling for $6 each.
$119,000
Preferred × $121,000 = $115,192
Stock: $119,000 + $6,000
$6,000
Common Stock Warrants: × $121,000 = 5, 808
$119,000 + $6,000
$121,000
whole or in part.
(Slide 3 of 3)
 Ponce makes the following journal entry:

Cash ($121 × 1,000 shares) 121,000
Preferred Stock, $100 par 100,000
Additional Paid-in Capital on Preferred
Stock 15,192
Common Stock Warrants 5,808
 Assuming all warrants are exercised. Ponce makes the
following journal entry to record the issuance of the
1,000 shares of element
List as an commonofstock in exchange for the
warrants and $40
contributed per inshare:
capital the
Cashshareholders’
($40 × 1000equity section
shares) 40,000
Common of the balance
Stock sheet
Warrants 5,808
Common Stock, $10 par 10,000
Additional Paid-in Capital on Common
Stock 35,808
whole or in part.
Callable Preferred Stock
 Callable preferred stock is stock that may be

retired (recalled) under specified conditions by a
corporation at its discretion.
 Example Li Corporation has outstanding 1,000
shares of $100 par callable preferred stock that
were issued at $110 per share and that have no
dividends in arrears.
 If the call price is $112 per share, Li makes the
following
Preferred journal entry
Stock, $100 par to record the100,000
call of these
Additional Paid-in Capital on Preferred Stock10,000
shares:
Retained Earnings ($112,000 ‒ $110,000) 2,000
Cash ($112 × 1,000 shares) 112,000
The debit to Preferred Stock is a permanent
reduction to Stockholders’ Equity.
whole or in part.
Redeemable Preferred Stock
 In contrast to convertible preferred stock and

callable preferred stock, some preferred stock is
redeemable.
 Redeemable preferred stock is stock that may
either be subject to mandatory redemption at a

specified future maturity date for a specified
price or redeemable at the option of the holder.
 Redeemable preferred stock has a key
characteristic of a liability because of the

obligation of a cash outflow in the future that
the company has no ability to prevent.
 Preferred stock that is redeemable at the option
ofLearning.
© 2013 Cengage theAllholder
Rights Reserved.is not
May not reported
be scanned, asor apostedliability.
copied or duplicated, to a publicly accessibleIt
webs ite, in
whole or in part.
Preference in Liquidation
 If a corporation is liquidated, the preferred

stock contract usually allows the preferred
shareholders liquidation preference over the
common shareholders (but secondary to creditors).
 The preference is typically expressed as a
percentage of (or equal to) the par value.
 It also frequently requires the payment of
dividends in arrears.
 A corporation discloses this information either
parenthetically in its shareholders’ equity
section or in the notes accompanying its financial
statements.
whole or in part.
What is Treasury Stock and
How is it Accounted For? (Slide 1 of 3)
 Treasury stock is a corporation’s own capital
stock that (1) has been fully paid for by the
shareholders, (2) has been legally issued, (3)
reacquired by the corporation, and (4) is being
held by the corporation for future issuance.
 A corporation may acquire treasury stock to:
 Use for share option, bonus, and employee purchase
plans
 Use in the conversion of convertible preferred stock
or bonds
 Use excess cash
 Use in acquiring other companies
 Signal to the capital market that the company managers

whole or in part. believe the shares are underpriced
 Reduce the number of shares held by hostile
shareholders and thereby reduce the likelihood of
being acquired by another company
 Use for the issuance of a stock dividend
 Treasury stock is not an asset.
 To ensure that treasury stock is handled in the
best interest of the shareholders, states have
passed laws regulating corporate activities as
follows:
 A corporation must acquire treasury stock for some
legitimate corporate purpose.
 Treasury stock does not vote, has no preemptive
rights, ordinarily cannot participate in dividends or
liquidation.
whole or in part.
 The acquisition of treasury stock does not formally
reduce a corporation’s legal capital.
 Treasury stock transactions may reduce retained
earnings but may never increase retained earnings.
 If the treasury shares are not retired, the
corporation may reissue the treasury stock at a
price above or below the acquisition price or the
par value.
 A corporation may account for treasury stock
transactions by either the cost method or the par
(stated) value method. The cost method is used by
the vast majority of companies that hold treasury
stock.
whole or in part.
Cost Method
(Slide 1 of 2)
 Under the cost method, when the corporation

reacquires its capital stock, it assumes it will
reissue rather than retire the stock.
 Example Ball Corporation is authorized to issue
20,000 shares of $10 par common stock and enters
into several treasury stock transactions as
follows:
whole or in part.
Cost Method
(Slide 2 of 2)
Note that treasury stock was Note that the retained

reissued at less than par. earnings account is
debited for $100.
whole or in part.
Balance Sheet Presentation
whole or in part.
How is the Contributed Capital
Section Structured?
whole or in part.
Real Report: Contributed Capital
(Slide 1 of 3)
whole or in part.
(Slide 2 of 3)
Questions:
1. What is the par value of Starbucks’s common stock? How many more
shares can Starbucks issue as of October 3, 2010? The par value of
Starbucks’s common stock is $0.001 per share. Starbucks has
authorized 1,200 million shares of common stock and has issued and
outstanding shares at October 3, 2010 of 742.6 million, so the
company may issue 457.4 million additional shares.
whole or in part.
(Slide 3 of 3)
2. How many shares of common stock did Starbucks repurchase and retire
during the fiscal year ended October 3, 2010? What was the effect of
these transactions on shareholders’ equity? What was the average
Starbucks
price paid per share acquired duringrepurchased
2010? and retired
11,200,000 shares of common stock during 2010. This reduced
Additional Paid-in Capital by $285,600,000. The average price for a
share of common stock was $25.50.
3. How many classes of capital stock have been authorized by Starbucks?
Starbucks has authorized both preferred and common, however, the
company has not issued any preferred shares.
whole or in part.

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INTERMEDIATE

1. Define equity and explain the corporate form of

 Equity is the residual interest in the assets

 Retained Earnings is an account in shareholders’

 Shareholders (or stockholders) are owners of a

 Privately held corporations are any

 Domestic corporations are companies doing

 In the United States, a corporation is a legal

 Capital stock refers to the shares of stock

 Common stock is capital stock that carries

 Authorized capital stock is the number of shares of

 To protect the corporation’s creditors,

 The par value of a corporation’s capital stock (either

 State law requires the corporation to record

 Capital in Excess of Par (or Stated) Value

 For both situations, the number of shares issued

 When a corporation issues different types of

 Brant makes the following journal entry:

 A corporation may incur miscellaneous costs

 Stock certificate fees

 Investors sometimes agree to purchase

Cash ($16 × 500) 8,280

 A nonmonetary exchange is any type of transaction in

 Stock may be closely held and not actively

 To reduce the market price of a corporation’s

 Example Ollar Corporation has 250,000

 Stock warrants represent the right to purchase additional

 The fair market value of the preferred stock is

 On July 1, 2016, the warrants are exercised to

arrangements intended to provide additional

company provides the share options to the

 On January 1, 2013 (the =grant

 Performance-based share option plans (or variable-

 Terms of the plan are that by December 31, 2015:

 Because some employees who qualify to buy shares

 Compensation cost for restricted share plans is

 On January 3, 2013, the $5 par value common stock is

 Taos would issue 10,000 common shares to the employee

 Share appreciation rights (SARs) are rights granted

 Example On January 1, 2013, when the market

 On the grant date, Wolf estimates that the fair

 The necessary entry is shown under the exhibit on

Compensation Expense 5,000

 A corporation must pay any applicable dividends to

 Noncumulative preferred stock is stock carrying

 Example Richland Corporation has outstanding 1,000

 Participating preferred stock is stock

 Convertible preferred stock is stock with a

 Ness makes the following journal entry at conversion:

If the total contributed capital eliminated for the

 A corporation may also attach warrants to

 Example Ponce Corporation issues 1,000 shares of

 Ponce makes the following journal entry:

 Callable preferred stock is stock that may be

 In contrast to convertible preferred stock and

either be subject to mandatory redemption at a

characteristic of a liability because of the

 If a corporation is liquidated, the preferred

 Use in acquiring other companies

 Signal to the capital market that the company managers

 Under the cost method, when the corporation

Note that treasury stock was Note that the retained

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