Chapter 11 Reporting and Analyzing Stockholders

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Chapter 11
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Chapter 11 Reporting and Analyzing Stockholders
Equity

• After studying Chapter 11, you should be able
  to
• Identify and discuss the major characteristics of
  a corporation.
• Record the issuance of common stock.
• Explain the accounting for purchase of treasury
  stock.
• Differentiate preferred stock from common stock.

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Chapter 11 Reporting and Analyzing Stockholders
Equity

• After studying Chapter 11, you should be able
  to
• Prepare the entries for cash dividends and
  understand the effect of stock dividends and
  stock splits.
• Identify the items that affect retained earnings.
• Prepare a comprehensive stockholders' equity
  section.
• Evaluate a corporation's dividend and earnings
  performance from a stockholder's perspective.

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Corporation

• Possess legal entity
• Created by law
• Has most of the rights and privileges of a person
• Classified by purpose and ownership
• Purpose - profit or nonprofit
• Ownership - publicly or privately held

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Characteristics of a Corporation

• Separate legal existence
• Limited liability of stockholders
• Transferable ownership rights
• Ability to acquire capital
• Continuous life
• Corporation management
• Government regulations
• Additional taxes

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Stock Certificate Shows...

• name of the corporation
• stockholder's name
• class and special features of the stock
• the number of shares owned
• the signatures of
  duly authorized corporate
  officials.

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Authorized Stock...

• Maximum amount of stock a corporation is allowed
  to sell as authorized by corporate charter.

Outstanding Stock...
Number of shares of issued stock that are
being held by stockholders.
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Corporations Can Issue Stock...

• Directly to investors (typical in privately held
  corporations).
• Indirectly through an investment banking firm
  (customary with publicly held corporations).

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Par Value Stock...

• Is capital stock that has been assigned an
  arbitrary value per share in the corporate
  charter.
• Is usually low because some states levy a tax
  on the corporation based on par value.
• The legal capital per share that must be
  retained in the business.

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No-Par Value Stock...

• Capital stock that has not been assigned a value
  per share in the corporate charter.

Stated Value of No-Par Stock

• Amount per share assigned by the board of
  directors to no-par stock.

Par Value and Stated Value have NO relationship
to market value.
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Stockholders Equity Section of a Corporations
Balance Sheet...

• Two Parts
• Paid-in (contributed) capital
• Retained earnings (earned capital).

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Paid-in Capital...

• Amount paid to corporation by stockholders for
  shares of ownership.

Retained Earnings...
Earned capital held for future use in the
business.
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Accounting for Common Stock Issues

• The issue of common stock affects only paid-in
  capital accounts.
• When the issuance of common stock for cash is
  recorded, the par value of the shares is credited
  to common stock.
• The portion of the proceeds above or below par
  value is recorded in an additional paid-in
  capital account.

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Issuing Stock Above Par

• If Hydro-Slide, Inc., issues an additional
  1,000 shares of the 1 par value common stock for
  cash at 5 per share, the entry is
• Cash 5,000
• Common Stock 1,000
• Paid-in Capital in 4,000
• Excess of Par Value

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Hydro-Slide, Inc. Balance Sheet (partial)

• Stockholders' equity
• Paid-in capital
• Common stock, par value 2,000
• Additional paid-in capital 4,000
• Total paid-in capital 6,000
• Retained earnings 27,000
• Total stockholders' equity 33,000

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Mead, Inc. Balance Sheet (partial)

• Stockholders' equity
• Paid-in capital
• Common stock,5par value,
• 100,000 shares issued and
• outstanding 500,000
• Retained Earnings 200,000
• Total stockholders equity
  700,000

BEFORE TREASURY STOCK TRANSACTION
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Treasury Stock...

• Is a corporation's own stock
• that has been issued
• fully paid for
• reacquired by the corporation
• held in its treasury for future use.

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Corporations Acquire Treasury Stock to...

• Reissue shares to officers and employees under
  bonus and stock compensation plans.
• Increase trading of company's stock in
  securities market in hopes of enhancing market
  value.
• Have additional shares available for use in
  acquisition of other companies.
• Reduce number of shares outstanding thereby
  increasing earnings per share.
• Prevent a hostile takeover.

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Purchase of Treasury Stock

• On February 1, 2004, Mead acquires 4,000
  shares of its stock at 8 per share.
• Treasury Stock 32,000
• Cash 32,000

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Treasury Stock

• The Treasury Stock account would increase by the
  cost of the shares purchased - 32,000.
• The original paid-in capital account, Common
  Stock, would not be affected because the number
  of issued shares does not change.
• Treasury stock is deducted from total paid-in
  capital and retained earnings in the
  stockholders' equity section of the balance sheet.

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Mead, Inc. Balance Sheet (partial)

• Stockholders' equity
• Paid-in capital
• Common stock,5par value,
• 100,000 shares issued and
• 96,000 outstanding
  500,000
• Retained Earnings 200,000
• Total stockholders equity
  700,000
• Less Treasury Stock
  32,000
• Total stockholders equity 668,000

AFTER TREASURY STOCK TRANSACTION
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Preferred Stock...

• Capital stock that has contractual preferences
  over common stock in certain areas.
• Dividends
• Assets in the event of liquidation
• Preferred stockholders do not have
  voting rights.

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Preferred Stock

• Assume Corporation issues 10,000 shares of 10
  par value preferred stock for 12 cash per share.
  
• Cash 120,000
• Preferred Stock 100,000
• Paid-in Capital in Excess 20,000
• of Par Value--Preferred Stock
• (Preferred stock may have either a par value or
  no-par value.)

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Dividend Preferences

• Preferred stockholders have the right to share in
  the distribution of corporate income before
  common stockholders.
• The first claim to dividends does not guarantee
  dividends.

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Cumulative Dividend...

• Is a feature of preferred stock entitling the
  stockholder to receive current and unpaid
  prior-year dividends before common stockholders
  receive any dividends.

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Dividends in Arrears...

• Are preferred dividends that were scheduled but
  were not declared during a given period.
• Are not a liability. No liability exists until a
  dividend is declared by board of directors.
• Must be disclosed in the notes to the financial
  statements.

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Dividends in Arrears

• Dividends in arrears (35,000 x 2 years)
  70,000 Current-year dividends
  35,000 Total preferred dividends
  105,000

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Liquidation Preference

• Is a feature that gives preferred stockholders
  preference to corporate assets in the event of
  liquidation.

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Dividend...

• Is a distribution by a corporation to its
  stockholders on a pro rata basis.
• Pro rata means that if you own 10 of the common
  shares, you will receive 10 of the dividend.
• Dividend forms
• cash
• stock

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Cash Dividend

• Is a pro rata distribution of cash to
  stockholders.
• A corporation must have 2 things to pay cash
  dividends
• Retained earnings
• Adequate cash

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Cash Dividend

• In many states, payment of dividends from legal
  capital is illegal.
• Payment of dividends from paid-in capital in
  excess of par is legal in some states.
• Payment of dividends from retained earnings is
  legal in all states.
• Companies are frequently constrained by
  agreements with lenders to pay dividends only
  from retained earnings.

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Entries for Cash Dividends

• Three dates are important in connection with
  dividends
• the declaration date
• the record date
• the payment date

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The Declaration Date...

• Is the date the board of directors declares the
  cash dividend.
• Commits the corporation to a binding legal
  obligation that cannot be rescinded.

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The Record Date...

• The date ownership of the outstanding shares is
  determined for dividend purposes. Dec 20
  No Entry Necessary.

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A Stock Dividend...

• Is a pro rata distribution of the corporation's
  own stock to stockholders.
• Is paid in stock.
• Results in a decrease in retained earnings and an
  increase in paid-in capital.
• Does not decrease total stockholders' equity or
  total assets.
• Is often issued by companies that do not have
  adequate cash to issue a cash dividend.

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Stock Dividends

• You have a 2 ownership interest in Cetus Inc.,
  owning 20 of its 1,000 shares of common stock.
• In a 10 stock dividend, 100 shares (1,000 x 10)
  of stock would be issued. You would receive two
  shares (2 x 100), but your ownership interest
  would remain at 2 (22 /1,100).
• You now own more shares of stock, but your
  ownership interest has not changed.

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Reasons for Stock Dividends

• To satisfy stockholders' dividend expectations
  without spending cash.
• To increase marketability of its stock by
  increasing number of shares outstanding and
  decreasing market price per share.
• To emphasize that a portion of stockholders'
  equity has been permanently reinvested in
  business and is unavailable for cash dividends.

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Stock Dividends

• A small stock dividend (less than 20-25 of the
  corporation's issued stock) is recorded at the
  fair market value per share.
• A large stock dividend (greater than 20-25 of
  the corporation's issued stock) is recorded at
  par or stated value per share.

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Stock Dividends

• Medland Corporation has 300,000 in retained
  earnings and declares a 10 stock dividend on its
  50,000 shares of 10 par value common stock.
• The current fair market value of the stock is 15
  per share.

Retained Earnings 75,000 Common Stock
Dividends 50,000 DistributablePaid-in
Capital in Excess 25,000
of Par Value
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Stock Split...

• Is the issuance of additional shares of stock to
  stockholders accompanied by
• A reduction in the par or stated value.
• An increase in number of shares.
• A stock split does not have any effect on total
  paid-in capital, retained earnings, and total
  stockholders' equity.

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Stock Split

• Because a stock split does not affect the
  balances in stockholders' equity accounts, it is
  not necessary to journalize a stock split.

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Retained Earnings...

• Is net income that is retained in the business.
• The balance in retained earnings is part of the
  stockholders' claim on the total assets of the
  corporation.
• Retained earnings does not represent a claim on
  any specific asset.

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Deficit...

• Is a debit balance in retained earnings and is
  reported as a deduction in the stockholders'
  equity section of the balance sheet.

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Retained Earnings Restrictions...

• Are legal, contractual or voluntary
  circumstances that make a portion of retained
  earnings currently unavailable for dividends.

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AMAZON.COM Balance Sheet (Partial) December 31,
2000 (in thousands)

• Stockholders' equity
• Paid-in capital Common Stock
  3,571
• Paid-in capital in excess of par value
  1,322,479
• Total paid-in capital 1,326,050
• Accumulated Deficit 2,293,301
• Total stockholders equity (deficit)
  (967,251)

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Kmart, Inc. Balance Sheet (Partial) (in
millions)

• Stockholders' equity
• Common stock, .01 par value
• 1,500,000,000 shares authorized -- 250,000,000
  503,294,515
• shares issued 503
  Capital in excess of par value
  1,695
• Retained earnings 1,261
• Total stockholders' equity
  3,459

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SARA LEE CORPORATION Statement of Cash Flows
(partial) For the Year Ended June 30,2001 (in
millions)
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The Payout Ratio

• CASH DIVIDENDS DECLARED ON COMMON STOCK
• NET INCOME
• measures the percentage of earnings
  distributed in the form of cash dividends to
  common stockholders.

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Return on Equity Ratio

• NET INCOME - PREFERRED STOCK DIVIDENDS
• AVERAGE COMMON STOCKHOLDERS EQUITY

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The Dividend Yield

• DIVIDENDS DECLARED PER SHARE OF COMMON STOCK
• STOCK PRICE AT END OF YEAR
• reports the rate of return an investor earned
  from dividends.

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Earnings Per Share

• NET INCOME - PREFERRED STOCK DIVIDENDS
• AVERAGE COMMON SHARES OUTSTANDING
• ...measures the net income earned on each
  share of common stock.

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Price-Earnings Ratio

• MARKET PRICE PER SHARE OF STOCK
• EARNINGS PER SHARE
• In order to make a meaningful comparison of
  earnings across firms, use the price-earnings
  ratio.
• The price-earnings ratio reflects the markets
  assessment of a company's future earnings.