Stockholders Equity

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Chapter 11

• Stockholders Equity

Financial Accounting 4e by Porter and Norton
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Equity Financing Issue Stock

• Dividend flexibility
• Ready markets
• Borrowing may not be feasible

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Equity Financing Issue Stock

• Less control
• Dividends not tax deductible
• Hurts some financial ratios such as ROE

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Expanded Accounting Equation
Assets Liabilities Owners Equity
Assets Liabilities Stockholders Equity
Contributed Capital
Retained Earnings
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Contributed Capital

• Common Stock
• basic stock of corporation
• has voting rights
• represents ownership interest

• Preferred Stock
• optional
• tailored to meet specific needs
• provides dividend returns with less risk

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Number of Shares of Stock

• Authorized

Issued -sold distributed
Outstanding - not repurchased or retired
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Par Value

• Legal capital
• Arbitrary amount stated on stock certificate
• also called stated value

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Additional Paid-in Capital

• Amount received in excess of par or stated value
  of stock

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Retained Earnings

• Net income retained in business (not paid out as
  dividends) since inception
• Reinvested in a variety of assets (not
  necessarily liquid)

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Preferred Stock

• Can tailor to specific needs of firm
• Stated dividend rate
• Often carries dividend preference over common
  stock

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Preferred Stock Features

• Cumulative
• Participating

• Callable
• Convertible

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Stock Issued for Cash
Example
Common Stock 10,000 ( 10 par value x 1,000
shares)
1,000 shares of 10 par value stock sold for
15 per share
Addtl Paid-In Cap. 5,000 ((15 - 10) x
1,000 shares)

• Journal Entry
• Cash 15,000
• Common Stock 10,000
• Additional Paid-In Capital Common 5,000

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Stock Issued for Noncash Consideration

• Record at fair market value of consideration
  given or received, whichever is more readily
  determinable

Title to land, building, etc.
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Treasury Stock

• Company buys back its own stock
• Contra-equity account (debit balance)
• Not outstanding (no voting rights)

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Presentation of Treasury Stock

• Common stock, 10 par, 1,000
• shares issued, 900 outstanding 10,000
• Additional paid-in capital 12,000
• Retained earnings 15,000
• 37,000
• Less Treasury stock, 100 shares
• at cost (25 per share) ( 2,500)
• Total stockholders equity 34,500

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Cash Dividends
Paid to
Stockholders on date of record
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Dividends

• Record dividends when declared not when paid

12/31/03
1/15/04
Reduce retained earnings
Pay dividends
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Recording Cash Dividends
Retained Earnings XXX Cash Dividend Payable
XXX To record the declaration of a cash
dividend.
Cash Dividend Payable XXX Cash XXX To
record dividend payment.
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Dividend Requirements

• Sufficient cash
• Positive retained earnings

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Dividend Payout Ratio
Annual dividend Net income
The of earnings paid as dividends
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Cash Dividends Example

• Stricker Company declares a 70,000
  dividend for 2004 (no dividends were paid in 2002
  or 2003).
• There are 10,000 shares of 10 par, 8 preferred
  stock and 40,000 shares of 5 par common stock
  outstanding.

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Cash Dividends Example
Noncumulative Preferred Stock

• Preferred Common
• Step 1 Distribute current-year dividend to
• preferred (10,000 shares x 10 par x 8 x 1 yr.)
  8,000
• Step 2 Distribute remaining dividend to common
• (70,000 - 8,000)
  62,000
• Total allocated 8,000 62,000

0.80 per share
1.55 per share
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Cash Dividends Example
Cumulative Preferred Stock

• Preferred Common
• Step 1 Distribute dividends in arrears to
• preferred (10,000 shares x 10 par x 8 x 2
  yrs.) 16,000
• Step 2 Distribute current-year dividend to
• preferred (10,000 shares x 10 par x 8 x 1 yr.)
  8,000
• Step 3 Distribute remaining dividend to common
• (70,000 - 24,000)
  46,000
• Total allocated 24,000 46,000

2.40 per share
1.15 per share
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Stock Dividends

• Issue of additional shares proportionately to
  existing stockholders

• Reasons
• insufficient cash
• market price reduction
• nontaxable to recipients

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Small Stock Dividend Example(Capitalize Market
Value per Share)
Before After

Stockholders Equity Common stock, 10 par,
5,500 shares 50,000 55,000 Additional
paid-in cap. 30,000 45,000 Retained
earnings 70,000 50,000 Total
150,000 150,000


-
Total S/E is unchanged
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Large Stock Dividend Example (Capitalize Par
Value per Share)

• Stockholders Equity
• Common stock, 10 par,
• 10,000 shares 50,000 100,000
• Additional paid-in cap. 30,000 30,000
• Retained earnings 70,000 20,000
• Total 150,000 150,000

Before After

-
Dividend deducted from retained earnings and
recorded in the Common Stock account at par.
Additional Paid-In Capital account is unaffected.
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Stock Splits

• Results in additional issuance of shares
• Reduces par value per share
• No change in Stockholders Equity accounts

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Stock Splits

• Not recorded in accounts
• Splits reduce market value per share and make
  stock more affordable to a wider range of
  investors

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2-for-1 Stock Split Example

• Stockholders Equity
• Common stock, 5.00 par,
• 10,000 shares 50,000 50,000
• Additional paid-in cap. 30,000 30,000
• Retained earnings 70,000 70,000
• Total 150,000 150,000

Before After
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Statement of Stockholders Equity

• Shows changes in all equity accounts including
• Sales and Purchases of capital stock
• Includes

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Book Value per Share
Total Common Stockholders Equity of Common
Shares Outstanding

• Rights of common stockholders in event of
  liquidation
• Generally represents floor price of stock

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Book Value vs. Market Value
From Delta's 2001 annual report Book value per
share 26.91 Market value per share in
2001 38.24 (avg.)

• Which value would you expect to pay for a share
  of Wrigley stock?
• What factors account for the difference between
  the two values?

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Appendix

• Accounting Tools
• Unincorporated Businesses

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Sole Proprietorships

• Not a separate legal entity so owner has
  unlimited liability
• Must keep personal and business records separate
• Business income is declared on the owners
  personal tax return and taxed at personal tax
  rate

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Sole Proprietorships

• Drawing or withdrawal and income summary accounts
  are closed to the owners capital account
• Owners Equity section of the balance sheet
  consists of the capital account

Beginning balance 0 Plus
Investments 10,000 Net Income
4,000 Less Withdrawals (6,000) Ending
balance 8,000
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Partnerships

• Unlimited liability
• Limited life partnership agreements can and do
  end
• Not taxed as a separate entity

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Partnerships

• Distribution of income
• Equal distribution
• Stated ratio
• Other allocation
• For example, based on salaries, interest on
  invested capital, and a stated ratio

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End of Chapter 11