The Analysis of the Statement of ShareholdersEquity

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Chapter 8
The Analysis of the Statement of
ShareholdersEquity
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The Analysis of the Statement of Shareholders
Equity
Link to Previous Chapter
Chapter 7 gave a design for
financial statements that
readies them for analysis.
This Chapter
How is the
How is dirty
-
What is hidden
This chapter reformulates the
surplus income
dirty
-
surplus
statement of
statement of owners equity
income ?
owners equity
treated in the
according to the design in
reformulated
reformulation ?
Chapter 7. The reformulation
to highlight the
information it
highlights comprehensive
contains ?
income.
Link to Next Chapter
Chapters 9 continues the
reformulation with the balance
sheet and the income
statement.
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Link to Web Page
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What you will learn from this Chapter

• How GAAP statements of shareholders' equity
• are typically laid out
• Why reformulation of the statement is
• necessary
• What is reported in "other comprehensive
• income" and where it is reported
• What "dirty-surplus" items appear in the
• statement of shareholders' equity
• How stock options work to compensate
• employees
• How stock options and other contingent equity
• claims result in hidden expenses
• How management can create (or lose) value for

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GAAP Statement of Shareholders Equity
Opening book value of equity (common and
preferred) Net share transactions with common
stockholders Capital contributions (paid in
capital from share issues) - Share
repurchases (into treasury stock or against
paid-in capital) Net share transactions with
preferred shareholders Capital contributions
(share issues) - Share redemptions Change
in retained earnings Net income - Common
dividends - Preferred dividends
Accumulated other comprehensive income
Change in unearned (deferred) stock
compensation Closing book value (common and
preferred)
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The Governing Accounting Relation

• Book value, beginning of period
• Comprehensive income
• - Net payout to shareholders
• Book value, end of period

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Reformulated Statement of Stockholders Equity
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Reformulation The Steps

• Restate beginning and ending balances for items
  incorrectly included in or excluded from common
  equity
• Preferred stock
• Dividends payable
• Unearned (deferred) compensation
• Calculate net transactions with shareholders
• Cash dividends share repurchases share
  issues
• Calculate comprehensive income
• Net income Other comprehensive income
• 
  Preferred dividends

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The GAAP Statement Nike Inc., 2004
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Nike The Reformulated Statement
Balances 2003 2004 Reported
3,990.7 4,781.7 Dividends
payable 36.9 52.6 Unearned
compensation 0.6 5.5 Restated
balance 4,028.2 4,839.8
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The GAAP Statement Reebok International Ltd.,
2004
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Reebok Reformulated Statement
Balances 2003 2004 Reported 1,033.7 1,
220.0 Unearned compensation 1.2
5.8 Restated balance 1,034.9 1,225.8
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Dirty Surplus Accounting in the US
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FASB Statement No. 130

• Requires the reporting of comprehensive income
• in one of three ways
• Within the income statement
• In separate statement
• Within the equity statement
• Most firms choose the last alternative

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Ratio Analysis
Payout and Retention Ratios
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Ratio Analysis (continued)
Shareholder Profitability Ratio
Growth Ratios
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Hidden Dirty Surplus

• Shareholders lose when shares are issued at less
  than the market price (e.g. exercise of options)
• This loss, however, is not recorded as expense.
• What is the nature of this loss? If options are
  part of a compensation package, this loss is an
  employee compensation expense. If from a
  conversion of a bond, preferred stock or
  warrants, the loss is a financing expense.
• What is the amount of the loss? Market price -
  exercise price.
• Special case options granted in the money are
  recorded as deferred compensation

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FASB Statement No. 123R

• Statement 123R requires an expense to be
  recognized at option grant date, equal to the
  value of the option at that date
• Up to 2006, pro forma net income, including the
  expense, was reported in footnotes. The expense
  must now be reported in the income statement.
• No further expense recorded as the option moves
  into the money or at exercise date.
• Firms record a tax benefit (for non-qualified
  options) at exercise date, and credit this to
  shareholders equity.
• IFRS2 has a similar requirement.

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Measuring the Loss from Exercise of Stock
Options Method 1 (Reebok)
Expense is implied from the tax benefit
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Measuring The Loss from Exercise of Stock
Options Method 2 (Reebok)
Calculate difference between average stock price
and exercise price
Use when tax benefit is not reported, or for
incentive options (where there is no tax benefit).
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Reebok Reformulated Statement
Shares are issued at market value, and the
difference between the market value and after-tax
receipts from the shares issued is a loss from
exercise of options.
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Hidden Losses on Put Options Dell Computer
From the 2002 equity statement (see Chapter 2)
The Loss
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The GAAP Statement of Shareholders Equity Dell
Computer, 2002
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Dell Reformulated Statement

• Dell Computer Corporation
• Reformulated Statement of Shareholders Equity
• Balance, February 2, 2001
  5,696
• Transactions with shareholders
• Shares issued in stock option exercises
• (at market) 1,747
• Shares repurchased (at market) (1,632)
  115
• Comprehensive income
• Comprehensive income reported
  1,222
• Loss on exercise of employee stock options
  1,391
• Tax benefit for employee stock options
  487 (904)
• Loss on put options
  (1,368) (1,050)

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Losses on Convertible Securities

• Loss Market price of common issued -
• Book value of convertible surrendered
• The market value method vs. the book value
• method
• - The market value method recognizes losses on
• conversion
• - The book value method records the shares at
• the book value of the convertible securities,
• with no loss recognized
• Almost all firms use the book value method.