CHAPTER 11 Reporting & Analyzing Stockholder’s Equity

1. CHAPTER 11Reporting & Analyzing Stockholder’s Equity

2. Ch. 11 Reporting & 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. • Prepare the entries for cash dividends and stock dividends. • 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.

3. 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 • Publicly Held -May have thousands of stockholders and its stock is regularly traded on national securities markets. • Privately Held -May have few stockholders and does not offer its stock for sale to general public.

4. Characteristics of a Corporation • Separate legal existence • Limited liability of stockholders • Transferable ownership rights • Ability to acquire capital • Continuous life • Formation of corporation • Corporation management • Government regulations • Additional taxes • Stockholder rights • see illus. 11-1, 11-3, p. 513

5. Illustration 11-4 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.

6. Questions in Issuing Stock... • How many shares should be authorized for sale? Authorized shares = Max. amount of stock a corporation is allowed to sell as authorized by corporate charter. Outstanding stock = # shares of issued stock held by stockholders. • How should the stock be issued? - Directly or through investment bankers. • At what price should the shares be issued? • Company's anticipated future earnings • Its expected dividend rate per share • Its current financial position • Current state of economy & securities market • What value should be assigned to the stock?

7. Par Value Stock… - illus. 11-5 • 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. No-Par Value Stock… Capital stock that has not been assigned a value per share in the corporate charter. Stated value = Amount per share assigned by the board of directors to no-par stock. Par & Stated Value have no relationship to Market Value

8. Stockholders’ Equity Section of a Corporation’s Balance Sheet... • Two Parts: • Paid-in (contributed) capital (“PIC”) • Amount paid to corporation by stockholders for shares of ownership. • Retained earnings (earned capital) (“RE”). • Earned capital held for future use in the business.

9. 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 a separate paid-in capital account.

10. Issuing Stock at Par Assume Hydro-Slide, Inc., issues 1,000 shares of $1 par value of common stock at par for cash. Cash 1,000 Common Stock 1,000 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 Excess of Par Val. 4,000

11. Hydro-Slide, Inc. Balance Sheet (partial) Illustration 11-6 & 11-7 • Stockholders' equity • Paid-in capital • Common stock $ 2,000 • Paid-in capital in excess of par 4,000 • Total paid-in capital $ 6,000 • Retained earnings 27,000 • Total stockholders' equity $33,000 • Mead, Inc. B/S (partial) • Stockholders' equity • Paid-in capital • Common stock,$5par value, • 100,000 shares issued & outstanding $ 500,000 • Retained Earnings 200,000 • Total stockholders’ equity $ 700,000 • before treasury stock transaction

12. 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. Why Acquire Treasury Stock... • 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.

13. Purchase of Treasury Stock On February 1, 2001, Mead acquires 4,000 shares of its stock at $8 per share. Treasury Stock 32,000 Cash 32,000 • 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.

14. Mead, Inc. Balance Sheet (partial) Illustration 11-8 • 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

15. 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. • 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.)

16. Preferred Dividend... Cumulative - Is a feature of preferred stock entitling the stockholder to receive current & unpaid prior-year dividends before common stockholders receive any dividends. No guarantee of dividend payment. Liquidation Pref. - feature that gives preferred stockholders preference to corporate assets in the event of liquidation. Arrears -Are preferred dividends that were scheduled to be declared but were not declared during a given period. Are not a liability. No liability exists until a dividends is declared by board of directors. Must be disclosed in the notes to financial statements. Dividends in arrears ($35,000 x 2 years) $ 70,000 Current-year dividends 35,000 Total preferred dividends $105,000

17. 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 - need RE, cash, declared dividend • property • script (promissory note to pay cash) • stock.

18. 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. On December 1, 2001 the directors of Media General declare a $.50 per share cash dividend on 100,000 shares of $10 par value common stock. The dividend is $50,000 (100,000 x $.50). 12/1 Retained Earnings 50,000 Dividends Payable 50,000

19. The Record Date... The date ownership of the outstanding shares is determined for dividend purposes. 12/10 No Entry Necessary. The Payment Date... • The date dividend checks are mailed. • January 20 is the payment date for Media General. • 1/20 Dividends Payable 50,000 • Cash 50,000

20. A Stock Dividend... • Is a pro rata distribution of corporation's own stock to stockholders. • Is paid in stock. • Results in a decrease in RE &increase in PIC. • 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. • 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.

21. 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 Distributable Paid-in Capital in Excess 25,000 of Par Value

23. #219085 THE CINCINNATI COMPANIES5 SHARES CINCINNATI FINANCIAL CORPORATION INCORPORATED UNDER THE LAWS OF OHIO CUSIP 172062 10 1 This Certifies that ELINDA FISHMAN KISS is the owner of ***5*** fully paid and non-assessable shares of common stock of the par value of $2.00 per share of Cincinnati Financial Corporation transferable only on the books of the Corporation by the holder hereof in person or by Attorney upon surrender of this Certificate properly endorsed. In Witness Whereof, the said Corporation has caused this Certificate to be signed by its duly authorized officers and its corporate seal to be hereunto affixed. Dated April 28, 1995 Robert J. DriehausSEALRobert B. Morgan Treasurer President

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

27. Retained Earnings (RE)... • 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. Deficit = a debit balance in RE & is reported as a deduction in the stockholders' equity section of the balance sheet. RE restrictions = legal, contractual or voluntary circumstances that make a portion of RE currently unavailable for dividends.

28. Kmart, Inc. • Balance Sheet (Partial) • (in millions) Illustration 11-18 • Stockholders' equity • Common stock, $.01 par value; • 1,500,000,000 shares authorized; • 493,358,504 shares issued $ 493 Capital in excess of par value 1,667 • Retained earnings 3,819 • Total stockholders' equity$ 5,979

29. Ratios • Payout = TOT. CASH DIV. DECLARED ON COMMON STOCK NET INCOME • … measures the percentage of earnings distributed in form of cash dividends to common stockholders. • Dividend Yield = DIV. DECLARED per SHARE of COMMON STOCK STOCK PRICE AT END OF YEAR …reports rate of return an investor earned from dividends. • EPS = NET INCOME - PREFERRED STOCK DIVIDENDS AVERAGE COMMON SHARES OUTSTANDING ...measures NI earned on each share of common stock. • P-E = MARKET PRICE PER SHARE OF STOCK EARNINGS PER SHARE ROE = NET INCOME -PREFERRED STOCK DIVIDENDS • AVERAGE COMMON STOCKHOLDERS’ EQUITY

30. Illustration 11-21 & 11-23 Ratios • P-E = MARKET PRICE PER SHARE OF STOCK EARNINGS PER SHARE • To make a meaningful comparison of earnings across firms, use the P-E ratio. • P-E ratio reflects investors' assessment of a company's future earnings. • Return on Common Equity Ratio (ROCE) or (ROE) = • NET INCOME -PREFERRED STOCK DIVIDENDS • AVERAGE COMMON STOCKHOLDERS’ EQUITY • ...measures the profitability from the stockholders’ point of view.